Greetings, welcome to the Orion Engineered Carbons’ Second Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. I’ll now turn the conference over to Diana Downey, Vice President, Investor Relations. Thank you. You may begin.

Thank you, operator. Good morning, everyone, and welcome to Orion Engineered Carbons conference call to discuss second quarter 2019 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 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 as of today, August 2, 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 GAAP 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 on our second quarter 2019 earnings conference call. I will start today’s call by providing general comments on our performance and the industry backdrop. Our CFO, Charles Herlinger will then provide detail on our financial results and related matters for 2019. Then I’ll come back and share some closing comments. We will then be happy to take your questions. Turning to Slide 3, we saw solid performance in the second quarter, which was in line with our expectations when we issued our last release. April, as we said previously was an improvement from March. May was stronger yet. But in June, particularly in the second half, volumes weakened in many of our end markets. During the quarter, we drew down our inventory levels, which contributed to a lower overhead absorption and thus a negative impact in our P&L of $4.8 million. Despite this, our adjusted EBITDA improved $6.9 million or 10.8% from Q1. Despite Q2, looking forward now to the rest of the year, we see uncertainty and trading conditions affecting demand generally and with customers continuing to be conservative about their stocking of the more premium grades of our Specialty business as they continue to manage their own supply chains with caution. While Q2 results improved substantially over Q1, we were down on the prior year record quarter, reflecting the challenging overall market environment for the industry, particularly in the Specialty business. While we saw an increase in Specialty volumes both year-over-year and particularly versus the first quarter mix continued to be weaker than our norm for the reasons just mentioned. In contrast, our Rubber business delivered a significant increase in adjusted EBITDA both compare to the prior year as well as the first quarter, reflecting the…

Thank you very much, Corning. Now turning to Slide 7. Year-on-year volumes were up by 1% adjusted for the plant consolidation in South Korea and up fully by 2.9% on a sequential basis, driven mainly by our Specialty business. Our adjusted EBITDA was $71.5 million for the quarter with basic EPS and adjusted EPS at $0.41 and $0.53 respectively. With our basic EPS a year ago benefiting by $0.35 as a result of the land sale in South Korea. The development of our adjusted EPS versus the prior year as well as the first quarter of this year is essentially in line with the development of our adjusted EBITDA. It’s also important to point out that a large part of the decline in our overall contribution margin per metric ton was attributed to unfavorable foreign exchange translation effects, mostly related to the strengthening of the U.S. dollar versus other key OEC currencies. Similarly, to underscore Corning’s comments made already regarding the development of our business in the second quarter, we would have been at $76 million of adjusted EBITDA rather than reported $71.5 million, had we not seen a strengthening of the U.S. dollar versus other currencies in which we trade. On Slide 8 on the top left hand side, the main drivers of the change in contribution margin from Q2 of last year are summarized. With the net impact of positive price mix associated mainly with our Rubber business eroded primarily by negative FX translation impacts, negative feedstock differentials and inventory movements as previously commented on by Corning. Although the Rubber segment continue to achieve the pricing levels is in the first quarter. This was in large part eaten away by having to absorb worsening negative feedstock differentials. Recovery of these negative feedstock differentials is key to ensuring that…

Moving to Slide 11, showing our key quarterly Specialty metrics. Volumes improved year-over-year as well as sequentially. Although gross profit per ton remained around the level of Q1 with mixed being the main challenge followed by FX translation effects. Excluding the FX effects compared to last year, adjusted EBITDA and gross profit per metric ton were $33.4 million and $680 respectively. On Slide 12, we take a deeper look at the main drivers in the Specialty business year-over-year with higher volumes only partially offsetting a negative impact from significantly weaker mix and with unfavorable FX impacts, negative feedstock differentials and increase in fixed cost and some energy impacts further impairing performance. Global trading conditions are quite volatile and we believe mix will remain somewhat of a headwind in the second half of the year. The appendix to our slide presentation includes a summary of the key metrics we have used to derive our expectations for the remainder of the year with a particular focus on changes in these metrics since the last quarter update. Please now turn to Slide 13. Rubber volumes were up 0.9% sequentially and up by 0.3% year-on-year, when adjusted for the plan consolidation in South Korea taking place at the end of Q2 last year. This growth should be seeing within the context of healthy overall tire demand, driven in large part by replacement tire demand but with a more challenging trading environment for our MRG products, where demand in large part is linked to OEM automobile activity. Having said this, MRG volumes improve compared to the first quarter of this year, largely due to the channel management actions recently taken. Gross profit per ton was up $34 per ton from a year ago on the back of pricing gains, despite significantly negative FX and feedstock…

Thank you. [Operator Instructions] Our first question is from John Roberts with UBS. Please proceed with your question.

Thank you. And Charles, it’s been a pleasure to work with you. And you set the bar high for your successor.

Thank you very much, John. Really appreciate that.

I’m suspecting that the automotive engineered plastics area was among the weaker areas in the Specialty blacks area. I wonder if you could compare and contrast that with the manufactured rubber products area. So I would say, they normally go through incident maybe tried that, it sound like you had more self help in some channel management issues in manufactured rubber that at least maybe it’s delayed the effect on manufactured rubber into the second half.

John, it’s Corning. Let me respond to that. So you might recall that earlier in the year we talked about how we were making some changes in channel management, particularly in China. And that was a headwind at that point, but we were thought this is the right thing to do for the long-term. So more than just demand, our numbers were impacted negatively by taking those actions. And I think what we’re saying at this point is we’ve got those actions behind us. We’ve recovered that volume. So that was sort of getting back to where we were to attach from really the market values. So I would say in general, our MRG obviously outpaced what you’d see for OEM production or engineering plastics going into new cars.

How you’d expect them to roughly track engineered plastics in MRG rubber on a solid basis?

Right. Also the majority of engineered plastics are really going into consumer goods, appliances, consumer electronics, that sort of thing, not automotive. So the one sector of that, that is automotive, that should track long-term with MRG. But generally speaking, it’s only that one segment of engineered plastics.

Got it, thank you.

Our next question is from Mike Leithead with Barclays. Please proceed.

Good morning, Corning and Charles.

Good morning.

Again, it’s been great working with you since the IPO and best wishes on your retirement. First on Specialty, it looks like you saw a bit of a pickup in demand sequentially, but GP per ton remains pretty challenged actually it maybe a little bit below the past two quarters. So can you just maybe peel back the composition a bit of that? I’m guessing it’s primarily a mix situation that’s still weighing on gross profit per ton there.

Yes. So I’d say there is maybe three ways to look at this and not just what’s happening, but what can we do with it. So number one, FX is a pretty big impact. And as in time where we can shift as appropriate where we have U.S. dollar feedstocks to move our selling prices into U.S. dollars. I see that as a positive. Obviously, we want to drive the more premium markets. So think of coatings and it’s everything from auto but also marine coatings, protective, decorative, that kind of thing, we were just talking about engineered plastics things like that. One of the long-term drives in this business though is that some of the lower margin end markets for us, let’s think about black pipe, they are in general growing at a higher rate than some of our premium ones. And so that’s a drag on this. However, it’s still a lot higher than Rubber Carbon Black. So for us as a group, I mean we want that business, we’re going to continue to drive it, but that’s going on. And I mean if you think about net EBITDA for the company, that’s a good thing.

Got it, okay. That’s a helpful breakdown there. And then on cash, the cash flexibility, obviously you’ve paced out CapEx a bit the past two quarters. Can you maybe just talk through what has been either moved out or canceled in your capital plan and also what further flexibility you might have on cash management if conditions don’t improve much over the next couple of quarters.

Mike, it’s Charles here. We really haven’t, we’ve just paced out as we thought we would do pretty much. We didn’t think it would be evenly distributed over the year. We do have some flexibility to manage some projects, but we’re basically on track with what we expected to be on the EPA work and indeed with the other major initiatives that we’re undertaking.

I mean we have a backlog of projects of good things that would add EBITDA of whether it’s through productivity or debottlenecking. And it’s a matter of just prioritizing that. And to be clear, the EPA work is heavy spent this year, next year. Next fall, we are mechanically complete in Ivanhoe. We have the vast majority of this behind us.

Got it, thank you.

Our next question is from Kevin Hocevar with Northcoast Research. Please proceed.

Hey, good morning, everybody. And I’d also like to extend my congrats to Charles. It’s been a pleasure working with you these last several years.

Thanks, Kevin. I’ll be around for a while.

Yes. I’d like to stretch that also.

Thanks.

Yes. And in terms of the -- you call it the differential impact in the quarter, could you give us a little bit of color there? Did that get worse as the quarter progressed and how you’ve kind of seen it since here in July? And it sounds like you expect – correct me if I’m wrong, that, that kind of remains stable? But obviously I’m always still kind of developing there. So could you give us just a little bit more color on that kind of how that’s trended, what it’s like now and expectations here as we go forward?

Right. So as we’ve gone through the year, we see [indiscernible] conditions what that might do to demand. I think we look for that to be more stable as we go through the rest of the year.

Got you, okay. And then you’re taking pretty significant pricing actions here in the U.S. Can you give us some thoughts there on what’s baked into guidance from those actions? And do you need -- is the U.S., where you’re seeing it the most and that’s why we’re seeing action there, or are the other regions also being impacted and you might have to take action in those regions at some point as well?

Well, so I would say the U.S. -- in Europe, we have some of the CBO passed through mechanisms already in place, so that in particular is more of an opportunity for the U.S. That said, we see us leading all this. As Charles said in the prepared comments, it’s that sort of the deal between us and our customers that we’re not in the oil business, than we pass through gains, losses and [indiscernible] to the customers, and we’re committed to driving that hard.

Okay, got you. And then last question on the Rubber business, usually, if I look back seasonally, the first quarter EBITDA isn’t all that different than the second quarter. But this year there was pretty meaningful improvement there from 1Q to 2Q. So what drove that improvement sequentially?

Well, so as I mentioned earlier, we made a big recovery in our MRG position in China. And I’d say that was an important part of it.

Got you, okay. All right, thank you very much.

Our next question is from Jon Tanwanteng with CJS Securities. Please proceed.

Good morning. Thank you for taking my questions. And congrats again, Charles, on the retirement plans.

Thank you.

My first question is, what are your expectations for feedstock pressure heading into the second half at this point? Did you increase prices in line with that expectation or just a catch up to where inputs have gone to date only?

So I think exactly where we are in pricing and how all that works out is commercially sensitive. And you can imagine we’ve got these discussions going on. Our view is that as those move, we should be able to recover those from customers, different contracts of different mechanisms. And if you look at our price increase formula or the announcement that we’ve made, we’ve talked about adjusting that going forward to explicitly have a differential surcharge.

Okay, got it. And then have you contemplated the impact of even more tariff and trade headwinds that they have been threatened by the White House, just yesterday?

Yes, yes. So we noticed that tweet as well. So those specific tariffs, they don’t really hit materials that we trade in. They do affect obviously overall global economic volatility. And to a degree, that’s why we came out with a range. We hadn’t anticipated that tweet obviously, when we put this all together. But we continue to believe we can make this guidance.

Okay, got it. And then finally, SG&A was a lot lower than we expected. Can we expect that run rate to hold or will move up and down appreciably from these levels as we’re going into second half?

It should be pretty much around where it is now. I mean, we benefit on fixed costs through FX. And those costs that are not denominated in dollars and with the strengthening dollar, it’s not set to the FX negative impact at the contribution margin level. But generally, where we are at the moment is a pretty good representation.

Got it. And then finally, I don’t know if you mentioned it earlier. But was there an update on the Evonik negotiations at all?

Well, just to say that we mentioned last time we were likely to file for arbitration and indeed we did in the last quarter.

Okay, understood. So moving forward, but no definite timeline?

No. I think, again, we run this business, that’s not coming in tomorrow. We’re highly confident. We’re going to make a substantial settlement with these guys in the fullness of time. But we just run this Company as though that’s not coming in tomorrow.

Okay, fair enough. Thank you.

[Operator Instructions] Our next question is from Chris Kapsch with Loop Capital Markets. Please proceed.

Yes. Good morning. So a question following up on the discussion around differentials. Just so the greater magnitude of adverse differential that you’re seeing, how much would you attribute that to this ongoing transition to the refinery industry’s ongoing transition to IMO 2020?

Well, we see a substantial portion in that. Things like, as they make that transition shifting more to diesel, which makes CBO our feedstock material that’s available. So from our perspective, there’s a strong linkage there.

Okay. And then if I look at the differential headwind by segment, it’s more pronounced and it’s not just because the Rubber segment is bigger, but it’s more pronounced, actually it’s more pronounced in the Specialty segment and vis-à-vis the Rubber segment. And that’s a little counter intuitive, because more of your business on the Rubber side is under contract. And I thought, under contract, you have a little bit more coverage in terms of some of the clauses, and you just referenced some in Europe, but some of the clauses that have been baked in to try to address, when these disconnects happen in terms of feedstock differential. So I’m just wondering, why is it that you’re seeing more of an issue here on the Specialty side per differentials vis-à-vis the Rubber Black? So are you seeing more of an issue on the Rubber Black vis-à-vis the Specialty side.

So let me just speak to both groups, okay. So in Specialty, we tend to be using more of the lower sulfur feedstock. So the exact dynamics with that are a little bit different than what we see in the rubber, where we tend to use the higher sulfur feedstocks, particularly in the United States. So they have a slightly different, let’s say, underlying dynamic underlying differential.

Got it, okay. So that makes – you’re more dependent on the higher sulfur feedstocks in Rubber Black more carbon. That explained. And then you talked about, I mean there is a pretty substantial degradation in the profitability and the Specialty side and you talked about a couple things that you’re trying to do internally. What – just more generally, what would be sort of inflections in which end markets, which would help that overall mix for that business to recover as you see the macro playing out over, not so much that balance of 2019, but maybe into 2020. Thank you.

Right. So the I think the way to think of that is, if you are picturing a graph of our profitability and thinking like where is the midpoint, like GP per ton. And then what products are, let’s say, on the good side of that midpoint. It’s moving those. So that is almost anything in coatings. So it could be auto, it could be decorative, happy homeowner, marine, protective, whatever. It’s pretty much anything in engineered plastics areas like adhesives and sealants beyond automotive, in particular, because that’s a pretty large volume for them. It’s inks and think about toner cartridges and I hope you all own toner cartridges that are high quality and don’t jam. It’s a range of those end marks that would be an improvement for us, as well as them simply having a higher growth rate than some of the lower ones.

Thanks for the color.

[Operator Instructions] Our next question is from Laurence Alexander with Jefferies. Please proceed. Hello, Laurence, go ahead.

Good morning. So three questions related about the Specialty Carbon Black business. First, can you talk a little bit about structural changes that might take several years to implement, but that could help improve the baseline for the business? Secondly, given this description of the businesses having like the good versus bad margin portions, what’s the difference in the growth rates that you’re seeing there? And then third, the discussion around gross profit excluding FX, is that intended to signal or reflect customer psychology that margins can also improve unless the dollar moves in the right direction.

Okay. So let me take those starting from the top. On structural, I think just for sensitive reasons, we don’t necessarily want to go into everything in there. But it’s amongst the things are, making sure you’ve got the capacity for your higher margin products. It’s making sure, you’ve got the ability to sell them and support that with your customers. It tends to be more differentiated products, a more differentiated engineered, engineer sort of sale. In terms of growth rates, well, we have to look at one for each end market and we see that as somewhat commercially sensitive. But in general, it’s sort of looking at the aggregate, we would say the lower margin ones have been growing at a higher rate. And FX, we put that in the report really just for the investor community, just to give a sense of – so what’s business performance, what’s really translational FX.

Have you looked historically at how the business has done catching up to the FX effect? I mean, like, what’s the lag effect?

So that’s an interesting question. I think that most of this has been the FX simply moving – bouncing in a range. If you’re going to look back over now several years, though generally speaking, we’ve seen the U.S. dollar strengthening, and that’s been a challenge. I think the thing for us in this is to look at where we’re especially using dollar denominated or dollar driven energy prices that is our feedstocks, and then moving those customers into a dollar denominated sales price. And that would net take this out or dampen this at least going forward.

Thank you.

We now have a follow-up question from Chris Kapsch with Loop Capital Markets. Please proceed.

Yes. Thanks for explicitly talking about the walk on the different contributors to the EBITDA bridge. On the inventory panel, and I’m focused on, Specialty segment in particular. Just wondering, is – so the inventory drawdown affected absorption variances, $4.8 million, I think you said in this quarter. What are the – what are those variances look like over the balance of 2019? Has that inventory hit have been taken, and now, your production rates should flow through and cost accounting on a more normalized basis? Or is this going to drag on profitability for the balance of 2019, and so we have a stronger demand environment?

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Hey, Chris, for – sorry, everyone for that. Not sure what happened. We had to shift the rooms. But the short answer is that we think we took out most of what we needed to do in terms of volume. In the second quarter, if we see trading conditions move or whatever we of course can take actions again. But I think we’ve seen the majority of it.

Okay. So the penalty to – on a cost accounting standpoint has been confined to the second quarter essentially, in the Specialty segment?

Yes. Correct.

Got it.

Yes. There was an impact in both segments in the quarter just for the record, but yes, we’ve made the adjustment we think we needed to make.

Thank you.

[Operator Instructions] Okay. There are no more questions at this time. I’d like to turn the conference back over to management for closing remarks.

So first of all, just thank everyone for the time with us. Sorry for the interruption to the phone connection. And then one more time just personally in live, thank you, Charles, for all your work to Orion. Charles will be with us through this year. But nonetheless, we’ve just made the announcement and just want to express my great appreciation for your guidance and driving this company forward over so many years. Thank you so much.

Thanks a lot, Corning. And thank you, everyone.

Thank you. This concludes today’s conference. You may disconnect your lines at this time and thank you for your participation.