Orion Engineered Carbons S.A. (OEC) Q4 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the Orion Engineered Carbons Fourth Quarter and Full-Year 2018 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Diana Downey, Vice President of Investor Relations for Orion Engineered Carbons. Thank you. You may begin.

Thank you, operator. Good morning, everyone, and welcome to Orion Engineered Carbons conference call to discuss fourth quarter and full-year 2018 financial results. I’m Diana Downey, Vice President, Investor Relations. With us today are Corning Painter, Chief Executive Officer, and Charles Herlinger, Chief Financial Officer. We issued our earnings press release after the market closed yesterday and have posted a slide presentation to the Investor Relations portion of our website. We will be referencing this presentation during this call. Before we begin, I’ll remind you that some of the comments made on today’s call, including our financial guidance, are forward-looking statements. These statements are subject to the risks and uncertainties as described in the company’s filings with the SEC. Actual results may differ materially from those described during the call. In addition, all forward-looking statements are made of as of today, March 7, 2019, and the company does not undertake to update any forward-looking statements based on new circumstances or revised expectations. Also, non-GAAP financial measures discussed during this call are reconciled to the most directly comparable IFRS measures in the table attached to our press release. I will now turn the call over to Corning Painter.

Thank you, Diana. Good morning, everyone. And thank you for joining us for our fourth quarter and full-year earnings conference call. We appreciate your time. I'd like to start today's call by providing the highlights from the fourth quarter and full year of 2018. Then, I will provide an update on what we're seeing in the market and update on our capital deployment and I'll share some insights for my first six months as the CEO of Orion. Our CFO, Charles Herlinger, will then provide detail on our financial results and discuss guidance for 2019. After that, I'll come back and share some closing comments. Then we will be happy to take your questions. Turning to slide four, we delivered solid results for the fourth quarter and delivered another record EBITDA for the full-year 2018. In the Specialty segment, with the strength of our product portfolio and execution of our marketing programs, we delivered significant year-on-year growth in the first half of 2018 before trading conditions began to soften, particularly in the automotive segment. In the Rubber segment, we went from strength to strength as we enjoyed last year's pricing gains and good execution. In 2018, we also positioned ourselves for the future by consolidating our Korean facilities to one site, adding acetylene carbon black to our portfolio, and successfully negotiating rubber price increases for 2019. I would like to thank the Orion team for their hard work and dedication to achieve these outstanding results. Please turn to slide 5. I believe capital allocation is a key responsibility of a CEO. I will not read the whole slide, but the point is, is that after paying our dividend and addressing a few must-do categories, we strike a balance amongst growth, M&A and opportunistic buybacks. In 2019, we will accelerate our must-do US environmental spending as our first plant that requires enhanced sulfur-removal capability must be onstream by April 2021. Based on current conditions for construction in the US, we estimate our total EPA CapEx through 2025 to be roughly around $190 million. This is before reimbursement from Evonik. Other priorities for us include safety, maintaining our plants, the expansion of specialty production with the new line addition in Ravenna and we identified a higher-return cogeneration opportunity. As a result, in 2019, we expect total CapEx to be roughly $80 million for EPA-related investment and roughly $100 million for base projects and the expansion in Ravenna. We expect our leverage to stay within the 2 to 2.5x range. To further emphasize the importance of capital spending, we just modified our long-term incentive plan metrics to now be split between ROCE and TSR. Annual bonus metrics remain primarily based on EBITDA. Last quarter, we announced the acquisition of Specialty Black capacity, an acetylene carbon black business in Europe. We're pleased with the people, the asset, the pace of the integration and our improved view of the opportunity in front of us. I'd like to share some of my observations of being the new CEO at Orion and expand on my comments from last quarter. First, the people here are passionate about Orion and carbon black and they know their stuff. That is essential. Second, we have ample opportunity in our core business of carbon black. Third, in Specialty, those opportunities include new applications such as lithium ion batteries, adding new products to our portfolio of existing applications like coatings, improving product quality and strengthening our overall applications capability, particularly in the US. Fourth, we talk a lot about Specialty, but the Rubber business is core to us also. We have numerous opportunities in upgrading our production facilities, variable cost productivity and implementing our win-win contract structures. We are taking action in each of these areas. For example, starting with what's most important, our people, our 2019 annual incentive plan offers greater line of sight for our employees by moving from using corporate performance across the board to local EBITDA and balance sheet metrics. Now, turning to slides six and seven, I'm pleased to say that Q4 adjusted EBITDA was $64.4 million for the quarter and adjusted earnings per share rose to $0.48 from $0.42 in the last year. These results were driven by a strengthening Rubber segment due to solid execution and strong spot pricing supported by robust market conditions. Total volumes were down by 6.1%, but this was mainly due to the planned consolidation in Korea and some year-end softening in China. EPS benefitted from improved financing costs and a lower effective tax rate. On slide seven, you can see the relative strength of our Rubber business in Q4. On a full-year basis, Specialty gross profit per ton developed nicely. We'll look at the current trend on the next slide. Moving to slide eight, you can see our Specialty business results for the fourth quarter. Revenue grew 10% to $126.9 million, reflecting a pass-through of higher feedstock costs to customers and base price increases, partially offset by lower volumes, product mix and foreign exchange translation effects. Volume was down 2.9%, reflecting a mix of inventory destocking and softening demand. Destocking by its nature tends to adversely impact mix and the slowdown in China automotive and other markets did as well. We also shifted some capacity to higher-margin technical rubber carbon black grades versus specialty volumes in our production slate in certain circumstances. As a result, gross profit per tons was $643.6 per ton, down 2.6% from prior year and below our target range. Turning to slide 9, our Rubber Black business delivered robust results in the fourth quarter. Overall Rubber volume was down by over 7.1% reflecting the plant closure in South Korea and MRG sales to the automotive OEM, particularly in China. Gross profit per ton grew 15.3% due to improving mix and base price increases, the timing between quarters of pass-through of feedstock costs and increased cogeneration income. This gross profit improvement flowed through to a 14.1% increase in adjusted EBITDA per ton. I'm once again pleased with the performance of our Rubber Carbon Black business. Fundamentally, manufacturing capacity for tires and mechanical rubber goods has been growing more rapidly than global carbon black capacity. Accordingly, we see this in our improving market environment for Orion. Pricing negotiations for 2019 are complete and will deliver strong pricing gains, despite the fact that a larger rubber customer who is covered by a multiyear contract that will not reset until 2020. In addition, our focus on technical rubber grades and productivity measures will continue to contribute to the strengthening segment. Now, I'd like to turn the call over to Charles who will discuss our financial results in more detail.

Thanks, Corning. Good morning, everyone. By way of reminder, the fourth quarter and full-year results with comparatives we're presenting today are prepared on the basis of US GAAP, consistent with the timetable we previously outlined to convert our financial statements from IFRS and euros to US GAAP and US dollars during 2018. As expected, the impact on our operating results of the conversion to US GAAP from IFRS is immaterial. You will, however, find for the sake of completeness a detailed analysis of these impacts in our annual filing on our website. By way of reminder, with US dollar and US GAAP conversion now behind us, we continue to be on track to be admitted to the Russell indices latest by Q2 of 2020. As previously discussed, we currently have effectively no passive investor ownership of our stock rather than the industry norm of roughly 25% to 35% of such ownership. With admission to the Russell indices, we expect to address this ownership imbalance. Starting on slide 10 and our consolidated fourth-quarter results, overall volumes decreased by 6.1% or 16,700 metric tons from the prior year's quarter to 256,200 tons, largely reflecting the impact of the plant consolidation in Korea and the softening of demand in China. On a like-for-like basis, that is excluding the impact of the Korean plant closure, rubber volumes were essentially flat, largely reflecting the high capacity utilization within our system. Revenues increased by 13.6% to $386 million in the quarter, primarily due to the pass-through of higher feedstock costs as well as base price increases and favorable product mix, offset somewhat by foreign exchange translation effects and, to a lesser extent, volumes resulting from the Korean plant consolidation. While our total contribution margin decreased reflecting the impact of the volume decline stemming from the plant closure in Korea and the consolidated development of our two segments, our overall contribution margin per ton increased by 3.7% in the fourth quarter to $505.1 versus $487.2 in the prior year's period, reflecting the underlying improved profitability mix of the business as a whole. For the full-year 2018, our basic EPS and adjusted EPS both increased strongly from the prior year by 87% and 42% respectively. Basic EPS reflects the boost to our net income from the land sale in Korea, lower financing costs due to the successful repricing of our debt during the year as well as a reduction in our effective tax rate to 28%, confirming a further improvement in 2018 of this key metric, partly as a result of the lower-than-average tax rate associated with the taxation of the gain on the sale of the land. Now turning to slide 11, referring to the top waterfall chart on the upper left-hand side of this slide, the decrease in contribution margin is mainly driven by the volume reduction in large part associated with plant consolidation in Korea as well as foreign-exchange translation impacts, partly offset by increased base pricing and mix improvements and the efficient pass-through of higher feedstock costs. The second waterfall chart on the upper right hand side shows the drivers of the change in adjusted EBITDA from $65.9 million to $64.4 million, with the decline of the contribution margin and increase in manufacturing costs being partially offset by lower SG&A costs and a favorable foreign-exchange impact on fixed costs. The waterfall chart along the bottom of the slide analyzes net income development, which increased slightly to $20.1 million. The one-time benefit of last year's US tax reform comprising $8.8 million included in Q4 of 2017 and the decrease in adjusted EBITDA of $1.5 million were offset by a lower underlying tax charge of $2.7 million, a $6.3 million reduction in finance costs as well as a reduction in depreciation expense of $1.8 million. Now turning to slide 12 showing our cash flow dynamics and our key balance sheet metrics as of December 31, 2018. For the year, we generated a strong $122 million in cash from operations despite the cash consumption impact of $65.6 million associated with higher net working capital, in large part as a result of higher raw material costs. This cash generate generation, together with gross proceeds of $64.7 million from the sale of our former plant site in Korea, comfortably supported our CapEx investment program at a level consistent with our expectations and the purchase of the acetylene black acquisition, SN2A. Other uses of cash over the same period included dividend payments of $47.7 million and the opportunistic repurchase of shares totaling $4.9 million. As a result, our cash position at the end of 2018 was $57.1 million. The company's non-current indebtedness as of the fourth quarter end was $643.7 million, with net debt at $635.5 million, taking our term loan B debt and local debt into account, which represents a leverage ratio of 2.2 times LTM adjusted EBITDA down from the comparable leverage ratio of 2.3 times at the end of last year. Now turning to slide 13. We are introducing our 2019 adjusted EBITDA guidance of $280 million to $300 million. This outlook is based on the assumptions that oil prices, exchange rates and feedstock impacts will not materially change from levels seen in the latter part of Q4 of 2018. In terms of other areas of guidance, we expect capital expenditures for 2019 to be around $100 million, comprising base CapEx of $70 million and the already announced specialty line investment in Ravenna, Italy. This excludes EPA-related CapEx, which is expected to be around $80 million before any reimbursement to us by Evonik for this expenditure. As for the remainder of our guidance metrics, we expect depreciation and amortization to be approximately $90 million to $95 million with our tax rate expectation for 2019 on pretax income at around 29% to 30%. I will now turn the call back to Corning who will wrap up our prepared remarks before we head to Q&A.

Thank you, Charles. There's been a lot of news and comments regarding automotive OEM and China in the media. I would like to take a few minutes to share what we are actually seeing on the ground and why we are confident in our guidance. We see a few macro trends playing out in our business. First, business confidence is a bit subdued presently. In terms of our markets, this is most true in China and less so elsewhere. We see this in our volumes. For example, comparing volume trends over several years leading up to and following Chinese New Year, we see a weaker trend this year. This reflects Chinese customers taking longer shutdowns around the holiday. Second, the automotive segment has been under some pressure, again, most significantly in China. We've seen this play out in our business as weakening specialty demand both from destocking and slowing underlying demand. Automotive OEM demand impacts several specialty markets including coatings, adhesives and sealants and engineered plastics. In contrast, our Rubber segment, carbon black for tires has held up well as you would expect since about 75% to 80% of global demand for rubber black is for replacement tires. About three quarters of our MRG carbon black goes into new cars and this has been impacted, particularly in China where our rubber sales are heavily weighted towards higher-margin technical rubber grades used in MRG. We are currently reviewing our MRG channel management systems around the globe and expect to see improvements in them over time. A third trend that is a small impact today, but will be more impactful in the medium to long-term is electric vehicle. While we are not internally planning on a second half rebound in China automotive OEM, we could see continued momentum in their EV segment. The rise of EVs will be good for the carbon black industry and Orion. I'm confident in 2019 for several reasons. First, while it is quite possible that conditions will pick up in the second half, we at Orion are not going to rely on that. We are basing our guidance and our internal plans on what we can clearly see today. We are going to be agile and adjust our plans as needed. Second, the fundamental market dynamics that have been the foundation of our specialty business remain intact and continue to provide solid conditions for long-term growth. The quality of our Specialty business execution remains strong despite some softening market conditions, which, as you may recall, we've seen before and from which we've seen a solid recovery before as well. The dip in our specialty margins reflects market factors impacting mix more than price reductions for like-for-like grades. We intend to preserve the value of our business and not chase growth in a soft market. Third, we expect to have another strong year in our rubber business. We are well-positioned with our pricing agreements for 2019 on the rubber side, which will offset the MRG mix impact. Also, it's not going to happen overnight, but we will get back on track in China MRG. Keep in mind that China is a relatively small market for our rubber business. Our key markets of North America and Europe are much stronger. If our Specialty business remains on the trajectory we're seeing at the start of 2019 and the economy in China remains subdued, we'll find ourselves towards the bottom end of the guidance range. On the other hand, robust performance on the Rubber segment, coupled with a pickup in the Specialty business in the second half of 2019, particularly in China, will position us towards the higher end of this guidance range. If I take you back to the start of the call, one of my key learnings from the last six months is that we have opportunity in our core carbon black business. We have a huge list of opportunities such as new product introductions, continuous improvement projects, cogeneration opportunities, technical innovations, application sales development and we will prioritize amongst these according to customer needs and market conditions. We had a great 2018, setting yet another record for the business based on solid strategy and good execution. We are prepared for whatever market conditions emerge in 2019. In Specialty, we have a broad portfolio and we will put an emphasis on maintaining quality, strengthening our capabilities and integrating the acetylene carbon black acquisition. In Rubber, we will execute our most impactful productivity projects and position our plants to produce the most critical products in a tight market. We're going to be agile in our production planning and stay close to our customers. Thank you. now, we will be delighted to take your questions.

[Operator Instructions]. Our first question comes from Michael Leithead with Barclays. Please proceed with your question.

Good morning, guys. I guess, first on the guide, I was a bit surprised at the emphasis on China on the rage, as I thought China was, call it, 5% of your business. So, can you maybe help clear up why China is so important to next year's performance? And with that, maybe touch on what you're seeing in your two biggest regional markets, US and Europe.

Okay. Yeah. So, China is for us – if we focus on Specialty, and I think that's really where the emphasis is, we gave some disclosure on Rubber around MRG, but I think the bigger impact for us in the Specialty area. China is about 15% market for our Specialty products. So, we make about 20% of that 15%, but the balance we export. So, it's an end destination for directly made carbon black. That's an impact for us. And beyond that, some of our customers where we're selling them carbon black in Europe or even in the US, their end market for their product is going into China as well. That's a little bit harder to measure, but that's a significant issue as well.

Got it. That's helpful. And then, Corning, could you maybe give us little bit more details on the revamped incentive program you're working on? And is it fair for us to assume it kind of follows on from what you learned at your former company when they realigned compensation structure?

Yes. You can make that second assumption. So, similar to both companies, moving from where you used a companywide number for performance, let's say, EBITDA and instead moving it to something that gives employees more of a line of sight. So, let's imagine you're in a plant and you're talking to the team and you're saying, look, we're going to reward you for good work, for hard work. When they're incented around the whole company, we can say that and I mean it, and it's all true of everybody and every plant does it, but it's just a little less immediate for the people at that site. And so, the concept here is we get people, greater visibility between their action going to a smaller pool and it's going to affect their bonus more correctly. That's all about the annual incentive plan. For the long-term incentive plan, what we put in there was just an ROCE component because I think capital spending is just critical for our shareholders, for our company, for your long-term trend and I wanted to make sure we have that in our incentive thoughts.

Great, thank you.

Thank you. [Operator Instructions]. Our next question comes from the line of John Roberts with UBS. Please proceed with your question.

Thank you. Can you hear me okay?

Yeah.

China was buying a lot of feedstock globally a couple of years ago and increasing the basis on your raws beyond just oil prices. Is it the opposite currently? And is there a very favorable basis versus oil on the raws that you are purchasing?

I think the question in the broadest sense is kind of what's the trend on differentials right now and do they trend up or down. And I say, in the current market, and now even talking about going into 2019, differentials continue to trend up. And I would say I think there's some imports – exports of CBO from the US heading towards Asia as well.

Why do you think that is? Why wouldn't the weakness in China have made that differential more favorable?

So, I think that there is continued challenge in a place like the US with shale gas, which is a lighter oil. I think just simply the availability of the heavy oil feedstock continues to get tighter. And then, for a company for Orion, we're focused very much on the Specialty side, so that also means that many sites were looking really for high quality, meaning also clean CBO. And that's just become scarcer and more competition for it.

And then, if you back out the Korean closure, it sounded like rubber black was essentially flat year-over-year in volumes. What do you think the industry was down?

Well, I think if you looked at overall tire, you'd have a look at that. I think from memory, I think in January, it was down 1% in terms of OEM portion of that. And then, you have to figure, that's only a portion of the overall tire market.

But as far as the whole of last year, John, goes, it's probably the range we've talked about before, 1% to 2%. Obviously, your question is more directed to going forward. That's too early for us to say. But, certainly, we think our performance was a little bit behind the market growth only because we're focused on maximizing mix and we're at pretty high capacity utilization levels certainly in Europe and the US and South Africa and our business in Brazil.

Thank you.

Thank you. Our next question comes from the line of Jeffrey Zekauskas with J.P. Morgan. Please proceed with your question.

Thanks very much. Your outlook for next year is for pretty flat EBITDA. In rough terms, do you expect EBITDA growth in Rubber black offset by some contraction in Specialty blacks? Is that the general arc of your change?

Pretty much, yeah.

Yeah.

Can you talk about the pricing dynamics in the Rubber black for 2019?

So, the prices for 2019 – for those who are new – are largely set the year before, certainly for Europe and North America. And the pricing dynamics was positive. Probably the biggest gains scored in North America than in Europe. These are areas where the pricing had been, I would say, below cost of capital. So, it's only logical and natural that those numbers would go up. And they moved up for us. We haven't really disclosed what we would expect. Obviously, we're going to have some mix effect with the MRG impact in all of this, but I would say we would see our gross profit per ton moving up next year, let's say, low double-digits.

Okay. I think you said at the beginning of the call that your EPA expenditures were $190 million through 2025 and they're $80 million for 2019. Roughly, what are they in 2020? Is that also another…?

It's another heavy year.

Yes.

And simply because we want to get on top of these projects, get them behind us for all the obvious reasons. Quite frankly, when we come to manage the spend, as you'd expect, we might find that to keep leverage on some of the vendors, although we have the commitment out there, the actual cash flow extends out a bit into the later year. In other words, into 2021. That's certainly likely. But in terms of CapEx commitment, the next two years, 2019 and 2020, they will be the heavier years certainly.

Right. And the EPA spending bears on both your Rubber black operations and your Specialty black operations in the US, is that fair?

Much more on the Rubber.

Yeah.

Much more on the Rubber. Do you have any rough estimate of when you might get some reimbursement from Evonik? Like, do you think it's a 2019 event or 2020 or 2021? Or if you had to put a probability on those three years, which year would have the higher probability?

Yeah. So, this is one of these things where, I think, it's obvious to say we have some level of discussions with Evonik. And I think when you're in a negotiation like this, your best shot at keeping that moving forward to a good outcome is just not to negotiate it in public. So, I'd really like to not move forward – not really comment a lot on where that's there. Obviously, if one can't agree, one goes through our resolution process, which can drag it out. So, that's on the table as a possibility naturally.

Sure. And then, lastly, with all of the EPA spending, is that capital that you think you'll get a return on or it's just kind of a cost of doing business?

It's the old way you do the calculation, John. I don't mean to be flippant about it. It's necessary, Jeff, to do the business – stay in business.

Sure.

On one hand. On the other hand, it is expenditure that doesn't have a sort of incremental, directly attributable return to it. I would say, however, the market – the moat around the business is going to increase the whole environmental requirements and knowledge how to do that and the ability for us to then, of course, through the scrubbing process use the higher sulfur feedstocks. So, there are some – depending on how you do the calculation, you can come up with some pretty meaningful benefits in that regard. Now, in our case, as you've already alluded to with your question on Evonik, the investments needs to be considered on a net basis. So, when you start factoring those altogether, it is not an uninteresting project, curiously enough.

Right. And then, lastly, raw materials went up for you in 2019. So, all things being equal, should you have – should you use less working capital in 2019 than you used in 2018? And will there be any net raw material price relief for you through your income statement in 2019?

To your first point, yes, if you're a betting person, so to speak. We, certainly, would not expect to see the same hit by any means in 2019 and we may claw some of it back in terms of working capital consumption. In terms of relief, I think – again, it's a function of oil price. And as your question alludes on the Specialty side, our margins will be boosted by a fall in oil prices, yeah.

Yeah. Okay, great. Thank you so much.

Thank you. [Operator Instructions]. Our next question comes from the line of Chris Kapsch with Loop Capital Markets. Please proceed with your question.

Yeah. Good morning. My question was a follow-up to the first one about just trends geographically and sort of the emphasis on China as a key variable in terms of hitting the low end or high end of your guidance. So, just want to make sure I understand that because you have the one plant in China, which I believe is technical and MRG grades which, therefore, flows into rubber black. And your answer to the prior question was more about specialties and presumably weakness in China showing up in other regions that you export to to China. So, I'm just wondering if you could actually talk about the geographic trends in other areas and where some of that China weakness is showing up indirectly. And then, if you could also just talk about – I'm guessing there is precipitous weakness for the technical and MRG grades in China, maybe very late in the fourth quarter and through the first couple of months of this year. Can you just talk about how that's trended and what do you think is influencing that? Obviously, weak automotive, but is there also – how vicious is the destock tied to those grades? And is any of it also tied to the notion that, in China, going into the winter, the supply chain anticipates shutdowns and, therefore, had built extra inventory, and so there is almost an exaggerated effect associated with the destock in the channel.

Okay. So, let's start with the first part of the question, where in the world are we exporting into China effectively. And we export into China from the US, from Germany, from Korea and actually from Sweden, would be the primary locations. And so, those are areas where those plants get a little bit less load when this plays out. And then, if we move to the issue of MRG in China, so you're absolutely right. That became more clear as time went on. And you could look at what's happened right now when you say, hey, look, we're down more in our volumes than, let's say, China tire is down, this China automotive OEM is down. So, how can that be? And you can explain it away with saying it's destocking, and I'm sure there's some destocking in that number. But the challenge with destocking is, it is hard to put precise understanding on how much destocking is. And I fear, at times, it's a little bit like just hoping, hoping it's destocking and, therefore, it's going to come back quickly. And we don't want to hope. I don't want to ever hope in business, right? We want to know. We want to work on things. And so, as we dug into the whole issue around MRG, we started feeling that there were some issues in our channel management approach that maybe we were being impacted more than our fair share. So, then once you see that, okay, this is something we now – once you understand it, you can go after it, you can go and work. And when I talk about self-help, sorting this thing out is an opportunity for self-help. Exactly how much is this an issue versus how much was destocking? To be honest with you, it's very hard to say. But that's what we're after and I don't think we're chasing a shadow. I think there is an opportunity there.

Got it. Corning, just following up on that dynamic, has it also undermined the pricing and, therefore, contribution margin for that particular piece of business, the technical MRG into China automotive OE?

So, I would say, that was – so MRG, by its nature, is more attractive than tire. So, when you lose that, right, in terms of your mix, it is definitely a drag. To get back in, once you're out there, price might play a part in that. But I don't think that's going to be primarily a price story. But it is going to be there in our mix. If I think about us versus other people in China, the impact to us is much smaller because China is just much smaller, but we were almost all MRG and technical rubber grade material. So, what we lose in China is probably a little bit more painful, let's say, on a per ton basis than if we were just playing the broad field in China. And in terms of getting back our volume and reloading that plant, worse comes to worse, I can put that stuff in a tire. It's just – we don't really want to give up the differentiated position that we've established.

Got it. And then, I guess, if you just look at the numbers in the 10-K and say, okay, as a percentage of sales, China is X. It understates – given the indirect exposure through exporting of specialties from other regions, which you mentioned, you're understating really the ultimate exposure to China. So, do you have a – I know it's not precise, but do you have a better feel for what that percentage of exposure to China is?

Yeah. I would say we have a sense of the range of how high that could be, which is, I would say, it would be another 50% to 100% of the volume that we sell into China, for Specialty that is.

No. I meant as a percentage of overall Orion sales, do you have a sense – if we just look at the…

Chris, it's difficult for us to tell. There are three pieces, right? There's a piece that we make and produce – produce in China and sell in China. It's easy. This is stuff that we sell from Europe or the US into China. We, obviously, know what that is. And those two numbers get us to about 15%, okay, of our total volume. The third piece is what customers are buying presumably from us in Europe, say, which then ends up in their products going into China. That is much more difficult for us to know for obvious reasons. And that is certainly from seeing the reaction of our customers in Europe to the slowdown in China. That is significant. Is it as much as what we sell in directly into China? Who knows? But it's significant.

So, if you say what we sold – making there and exporting in, if we say that's 15%, I'm going to say, I would think that our overall into China is at least 20%. And at the absolute upper end, in my opinion – don't have it nailed – it would be in the high 20s, maybe even 30. But it's in that kind of a range where our customer products are running. And I think for some of our customers who make master batch and so forth, there's some momentum of how they shift around where their products are going.

Okay. Yeah, thank you. And then, I guess, finally, just a question on something that we hadn't heard a lot about in maybe the last couple of few years, but feedstock differentials. They've been benign when there are some alterations to the supply agreements in the Rubber black for not just you, but really most industry players, I believe. So, in this formal comment, there is a mention of adverse differentials. Just wondering, like, what's baked into your guidance for 2019 in terms of feedstock differentials? And also, if I understand what you're commenting, Charles, earlier about, once the scrubber equipment is in and you're able to use higher sulfur feedstock, then does that represent a potential inflection for maybe what might be a feedstock differential headwind in 2019 could turn to – flip the other way in 2020?

Your first question, it's factored into our guidance of the differentials we had in the late stage of Q4 of 2018. In terms of the ability to use higher sulfur feedstocks in – once you've got the scrubbing in place, that is certainly a potential advantage. But what we've done, Chris, and we've talked about this previously, is in all our contracts, we have a clear provision for us to recover IMO 2020, if you want to call it that, increases in feedstock due to the new sulfur content rules. And so, I think that cuts both ways. So, if we're looking to recover those costs, which we are in our contract, and then later on we can use cheaper or higher sulfur feedstocks because we've got scrubbing in place, then we're going to be having a sort of open communication at that time with our customers. It certainly makes us more competitive. That is the agreement we have in place. So, we are insulated pretty much on the downside, but we shouldn't expect to have a big windfall on the upside.

Thank you.

Thank you. [Operator Instructions]. Our next question comes from the line of Kevin Hocevar with Northcoast Research. Please proceed with your question.

Hey, good morning, everybody.

Good morning, Kevin.

It sounds like a lot of different moving pieces in terms of volumes, how to think of volume divide – the tire side of the rubber, the MRG side of the rubber and then specialty. Could you kind of layout what's your expectations for volumes if we kind of break it out into those three categories? What's your expectations for volumes for those here in 2019?

So, if we start then on tire, that's probably the most predictable baseline that we have. We see right now very strong demand in North America and in Europe. Actually in brazil as well. And we don't really – we see that continuing. And we, certainly, see that continuing almost regardless of minor variations in OEM, manufacturing, automobiles, just because in those markets, the replacement market is so very significant. So, I think that's a pretty solid program for us. If we think about MRG in those two markets, so we have a little more exposure there to what we see in automotive OEM manufacturing, but I'd say in general we see that as largely holding up for us. And what we might expect to happen in OEM, that's all in our guidance. For China, we're currently on a low number. And we're looking to, over the course of this year, sort of rebuild what we've got in that market. If I shift to specialty, so we look at where our current kind of rates are, as we look at our run rate going into this quarter, what we see in January February, making adjustments for Chinese New Year and so forth, we're looking at basically a trendline off of that. I want to be clear. We're not going to make guidance based on a hockey stick. What we're giving you guys is guidance that's based on what's real, what we see and we look at how December went year-on-year compared to other years, how we see January/February. And so, we see these things going on, let's say, a trajectory from where they are now. That's what you might expect, but not like some kind of gigantic hockey stick in the second half. I hope the world economy changes and all that plays out, but I just don't think that's a basis for guidance.

Okay, got you. And then, obviously, we just kind of kicked in the 2019 contracts here earlier in this calendar year. What do you need to see as we go through this year to be able to get pricing again in 2020? I don't think that there's too much in terms of capacity coming online. It sounds like, at least, from the tire side, you expect some volume growth. So, I guess, what do you need to see to position you guys well to get pricing again in next year.

So, I think if things simply continued as they are, it would be another good pricing year. And I'm talking about Europe and North America because that's where this contract structure is in place. It's a little bit different in Asia. We see, even right now when there's glitches in the supply chain at someone's location, there's a real struggle to get the spot opportunities for them. I'd also say, during the course of this year, different plants, carbon black plants are going to be taking outages to set things up for their EPA work. We'll have a short one coming up later this month. So, that's going to impact capacity as well. So, the truth is not much has to change. It just, I think, carries on and it's just the natural and logical consequence of many years of non-investment [ph] in carbon black, investment in the tire and now building on to that, let's say, people who used to export into the US – tires, that is – who are now building facilities to manufacture in the US. And those simple trends that are out there and they're playing out and we're getting qualification volumes right now for new lines, that's just setting the stage for this.

Got you. Okay, thank you very much.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I'll turn the floor back to Mr. Painter for any final comments.

Thank you all for joining us today. We appreciate your valuable time and that you gave us this time. We hope you all have a great day and a wonderful weekend. Thank you very much.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.