Orion Engineered Carbons S.A. (OEC) Q3 2019 Earnings Report, Transcript and Summary

Greetings. Welcome to Orion Engineered Carbons Third Quarter 2019 Earnings Conference Call. [Operator Instructions]. Please note, this conference is being recorded.I'll now turn the conference over to Diana Downey, Vice President of Investor Relations. Ms. Downey, you may now begin.

Thank you, Operator. Good morning, everyone, and welcome to Orion Engineered Carbons conference call to discuss our third 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 the 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 as of today, November 1, 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 for our third quarter 2019 earnings conference call. I will start today's call by providing general comments on our performance and our positioning in the current macroeconomic environment and industry backdrop. Our retiring CFO, Charles Herlinger, will then provide detail on the financial results and related matters for 2019. Then I'll come back and discuss the segments and share some closing comments. We will then be happy to take your questions.Before getting started, though, I'd like to thank Charles for his leadership to this company from the very start. In our recent announcement, we talked about Charles' many accomplishments, including going public, converting to U.S. dollars and U.S. GAAP. I would like to add my personal thanks for Charles tremendous support and the report we have built during my first year. Thank you, Charles. I'm very pleased that Lorin Crenshaw will be taken over as CFO of the Orion group at the start of next week, ahead of Charles' retirement at the end of the year, facilitating a smooth transition.Lorin brings a wealth of public company finance and broad chemical sector experience to Orion. He's a strong leader, a team player, and we are looking forward to his joining our management team and working with Charles during the transition period. Turning to Slide 3. Consistent with our forecast at the beginning of the year, we have seen weakness in Asian markets and with the automotive OEMs. Other key markets have weakened, as the year played out, along with a softer, broader economy. We navigated this challenging market environment to achieve strong cash generation and strong realized rubber segment pricing by focusing our attention on the areas within our control. Orion's operating performance continue to generate more than enough cash to fully fund our dividend. We remain confident and determined to ensure that Orion will emerge from this slowdown stronger and better positioned competitively to take advantage of our future growth opportunities.In Q3, Orion's adjusted EBITDA was $68.1 million, with Specialty at $30 million and Rubber Carbon Black at $38.1 million. Without the unfavorable FX impact, related to the stronger dollar, which was nearly all translational, Orion's adjusted EBITDA would have been $71 million, pretty much in line with the prior year.We expect conditions to remain weak through the rest of 2019. Against this backdrop, the stability of replacement rubber tire demand continues to provide a solid underpinning for our business as a whole. As a result of these market dynamics, we are tightening our 2019 adjusted EBITDA guidance range to $265 million to $275 million. Before we review the quarter, I want to share with you how we've positioned Orion to operate effectively in this environment. Slide 4 shows that we've positioned the business for the future by taking a number of key actions. We implemented a leaner management structure where leaders of our global business units also have regional responsibility, and we executed a reduction in forced focused on senior roles and simplification.Over the course of the year, we have eliminated approximately $5 million in costs, primarily in the senior ranks, equating to slightly more than 10% of the positions that participated in the 2018 long-term incentive plan, while at the same time, we've added highly experienced key executives. We refinanced our loan debt last year and renewed our revolving credit facility this year at even more attractive rates, with no maturities until 2024.With total debt service cost comprising of both interest and mandatory repayments of some $25 million per year, we are very comfortable with our ability to meet our commitments. Our covenants, which you can see in the back of slides, also provides us with a lot of flexibility. We increased Rubber Black prices in the 2018 and 2019 cycles, and we are determined to do the same for agreements starting in 2020.We have our EPA-related CapEx spend well underway and expect the majority of the spend to be behind us in just five more quarters. After that, our available cash flow increases significantly and all of this is before the anticipated reimbursement from Evonik for a significant portion of these costs at the conclusion of the arbitration process. Finally, over the course of several years, we have rightsized our manufacturing footprint with consolidation of plants in Korea and closures in France and Portugal. We are well positioned with a resilient business model for 2020.Sustaining a healthy cash flow profile during challenging economic times is paramount. On Slide 5, we share some perspectives on this. To be clear, we are able to sustain positive cash flow to fund our dividend, even if the economy deteriorated significantly. We've demonstrated the ability to proactively manage cash in the face of a softening demand by running our business lean and curtailing our non-EPA-related CapEx investments. Beyond that, lower feedstock prices and volumes in the downturn will improve our cash flow profile through the release of working capital and the reduction in cash taxes. As a result, we are confident that our $0.80 per share dividend is both safe and sustainable. Indeed, inside Orion, we are eager to prove that we can execute the first EPA projects, fully fund the dividend and whether whatever 2020 brings, while simultaneously positioning ourselves for the future. After 2020, the EPA CapEx spending will fall dramatically, averaging around $20 million per year for the next three years, in contrast to the $60 million to $65 million of investment taking place in 2019 and 2020.Given the current market weakness, as we look at our capital allocation priorities in the near term, we don't feel like we are missing opportunities by postponing growth CapEx projects. With significant growth returns to our core business, we can easily restart our core business growth projects. In the interim, our dividend will remain safe and our shareholders will be compensated to wait out the current macro headwinds.With regards to our capital allocation options, some investors have asked about corporate share repurchases. While we understand their perspective, managing cash in turbulent times, providing confidence around our dividend, getting the bulk of the EPA work behind us and preserving the ability to execute high-impact projects are our priorities. That being said, the confidence of our management and directors in the future of the business is reinforced by their acquisition of more than 0.25 million shares recently. Management is fully aligned with our shareholders.I believe there are actions to be taken in every economic season. On Slide 6, we list some of the to-dos for an economic downturn. Of course, the first thing is to get your costs right. But not just cut costs short term but rather take out costs that will not come back in the future. For example, one way we reduce cost is by going to a leaner, global business and regional management structure. We don't need to reverse that when things get better, those costs are eliminated. Next, we use the downturn to stay close to our customers, advance new products and address structural issues. And as I mentioned before, we are using this downturn to demonstrate our resilience to market weakness by executing the bulk of the EPA work while maintaining our dividend. By taking these and other actions, I am confident that we will emerge from any downturn stronger than before.Now let's move to our Q3 results on Slide 7. Adjusted EBITDA decreased by $4.5 million year-over-year. In the table, you can see that pricing mix were very strong for us, while volume, feedstock differentials and FX, mainly translational, were negatives. You can also see the impact from executing an inventory drawdown as we did last quarter, although, this quarter was considerably small. Looking forward to the rest of the year, we see an ongoing uncertainty in the marketplace, in general, with customers continuing to be cautious about stocking our Specialty Carbon Blacks as they manage their own supply chains.Specialty and MRG volumes were soft in all regions and for Specialty across nearly all applications. Type-related volumes were down slightly from prior year and up slightly sequentially with the Americas and EMEA holding steady for us. From a regional perspective, our Specialty volumes in Asia were down from the strong performance last quarter, but essentially at the level of it a year ago.In EMEA and the Americas, Specialty volumes flipped relative to prior year on broad-based lower demand. All in all, we're satisfied with our results, given the current economy and translational FX headwinds. I will now turn the call over to Charles Herlinger.

Thank you very much, Corning. Now turning to Slide 8. Year-on-year volumes were down by 3.9% and down by 5.2% on a sequential basis. Our adjusted EBITDA is $68.1 million for the quarter, with basic EPS and adjusted EPS at $0.40 and $0.52, respectively. The development of our adjusted EPS versus the prior year quarter as well as the second quarter of this year is essentially in line with the change of adjusted EBITDA versus these quarters. It is also important to point out, that a significant portion 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 against the euro. We would have been at fully $71 million of adjusted EBITDA rather than the reported $68.1 million that we not see the strengthening of the U.S. dollar.On Slide 9, on the top left-hand side, the main drivers of the change in contribution margin from Q3 of last year are summarized. With a net impact of positive price mix associated mainly with our strength in rubber business, eroded by negative feedstock differentials, negative FX translation impacts as well as by lower sales volumes and lower energy sales. Recovery of these negative feedstock differentials is key to ensuring that we have a stable rubber business platform and indeed consistent with the long-established general principle that we pass on to our rubber customers, both positive but also negative movements in the pricing of feedstocks we use to manufacture our products. This is, of course, a focused-driven negotiation agreement with customers beginning in 2020.Moving further down the P&L, the change in contribution margin was also the main driver of the change in adjusted EBITDA, together with additional fixed costs associated with higher than usual plant maintenance costs, offset by lower SG&A costs and favorable FX impacts on our fixed costs.The waterfall chart along the bottom of this slide shows that the change in net income is mostly driven by the decrease in adjusted EBITDA offset by lower taxes.Now turning to Slide 10, showing the positive development of our cash flow year-to-date as well as a forecast of cash flow within the provided adjusted EBITDA guidance range for the remainder of 2019. The first nine months of the year, our cash flow from operating activities totaled $142.7 million, in which working capital overall remained at a level consistent with the start of the year. This performance underscores our ability to generate positive cash flow to operate our business and fund our dividend, even in a weaker economy and without a significant working capital benefit so far are still addressing EPA-related CapEx investment needs.Slide 11 summarizes our overall financing structure and shows the long maturity profile of our entire debt package and our key balance sheet metrics as of September 30, 2019. The company's noncurrent indebtedness as of the second quarter end was $621.1 million with net debt of $616.4 million, taking our term loan B debt and local debt into account, which represents a leverage ratio of 2.3x LTM adjusted EBITDA, which is well within our target range, further underscoring the sustainability of the Orion business.While our intention is not to draw down our revolving credit facility on a regular basis, having this very competitively priced back stock in place assures us that Orion can weather pretty much any economic storm that the global economy might throw at us, while continuing to comfortably fund our dividend. Furthermore, and to draw your attention to the details we've included in the appendix to this presentation regarding the operating flexibility provided by the few debt covenants we do have. I will now pass the call back to Corning.

Thank you, Charles. Moving to Slide 12, showing our key quarterly Specialty metrics, which are below the prior year quarter. However, GP per ton improves sequentially and adjusting for FX, gross profit per ton was above $720. While I'm pleased with the improvement in this metric, recognized that mix is an important driver for GP per ton. Impacted by both varying demand across different applications as well as the rise and fall of regional end markets. For example, over the course of many years, some of our lower-margins Specialty markets have grown more rapidly than the higher-margin markets. Although, not in premium markets, this growth is attractive and does good for the overall development of adjusted EBITDA of our business, even though it dilutes GP per ton.The next slide breaks out the major drivers of adjusted EBITDA walk from prior year's quarter. A somewhat improved mix and a modest base price improvement were more than offset, primarily by significantly weaker volumes, FX impacts and negative feedstock differentials. Volume is clearly the biggest challenge right now. Most importantly, we are not going to chase volume in a weak economy for the sake of volume alone. On the contrary, we are working hard to recover feedstock costs, including differentials. In July, we announced a $0.07 per pound price increase for our Specialty grades in North America as well as an enhanced price list for certain services.I recently met with several Specialty customers from many regions and end markets. A common view is that the fundamentals of their business remain sound and the long-term drivers of demand remain solid. They believe they are suffering from the well-reported uncertainties in the economy, most share my view that we need to be prepare for tough sledding for some time to come. We are clearly already seeing this in our volumes and so are our Specialty customers. The appendix store slide presentation includes a summary of the key metrics we have used in setting expectations for the remainder of this year.Now please turn to Slide 14. Rubber volumes were down 2.9% year-on-year and 2.3% sequentially. Overall, Rubber Carbon Black demand for tires, driven large part by the replacement tire demand remains healthy, but slower OEM automobile activity has impacted MRG demand. Gross profit per ton, excluding FX impacts, was nearly flat at $302 per metric ton and adjusted EBITDA at $39.4 million.Slide 15 shows the adjusted - the development of adjusted EBITDA, which is in line with the changes in gross profit. You can see the significant positive impact from pricing against unfavorable FX impacts and the very significant negative differentials being partially offset by improvement in fixed cost levels and energy-related items.To address the differentials going forward, in July we announced a price increase of $0.08 per pound for rubber grades, structured as a $0.04 base price increase and $0.04 to account for CBO differential surcharges. We believe these increases are fair and should begin as soon as agreements permit. We're simply looking for our customers to live up to the intent of our mutual business model that we create value by converting feedstocks into engineered Carbon Black and pass-through feedstock costs whether arising or fall. Failure to do this inevitably leads to further under investment and lack of Carbon Black supply capability. We expect that the positive effects of these price increases will largely begin to take effect in the first quarter of next year.On Slide 16, we've summarized the three issues that Orion and the Carbon Black industry as a whole are addressing regarding feedstock costs. There our couple of key points. First, the IMO 2020 or Marpol impact on the spreads between high-sulfur and low-sulfur feedstocks is being largely addressed by indices in customer contracts were in place. For non-index customers, for example, in the case of our premium Specialty products, the cost pass-through objective is achieved through negotiation. We remained committed to recovering these Marpol 2020 related costs, although we may inevitably experience some fluctuations between our quarterly results relating to timing effects. Second, IMO 2020 has some broader impacts. It makes North American Rubber Carbon Black more competitive on the world stage relative to Carbon Black made with low-sulfur feedstock in other locations. This creates yet another barrier to imports.Similarly, IMO 2020 will increase some winners and some losers in local markets depending upon market specifics. We are working to make most of the opportunities and minimize the challenges, which, between the two of these, I believe, will be largely a loss for us.As previously discussed, a feedstock differential occurs because the actual cost of purchasing a given feedstock is really identical with the index used in customer contracts to reflect the cost of the feedstock. These differentials have been worsening in recent years as our feedstocks are getting lighter due to a number of reasons, including the oil shale bloom. We believe that Marpol 2020-related impacts have also exacerbated negative feedstock differentials.Turning to Slide 17, here you can see the key assumptions behind our guidance. While 2019 is shaping up to be a relatively tough year for our industry, we are, as a management team, busy taking the appropriate actions for downturn, while also working hard to make the most of the opportunities this creates. While economic conditions are challenging, our business remains robust, and we have taken appropriate cost and pricing actions to deal with this environment. As a result, we expect to end the year within our guidance range at between $265 million to $275 million of adjusted EBITDA. Other areas of guidance for 2019 remain unchanged, except that we now expect our non-EPA capital expenditures to be about $80 million and our U.S. EPA settlement-related CapEx to be in the range of $50 million to $55 million before any reimbursement to us by Evonik for this expenditure. With our group overall tax rate for the year at 29% rather than 30%.We are pleased with our performance in this environment, and we will continue to manage our cash and capital spending closely in order to optimize cash generation. In line with our current milestone planning, with just five more quarters of elevated EPA CapEx before it falls to around the $20 million per year range. We are confident in our ability to manage through the duration of the spend, while maintaining capital efficiency. This requires trade-offs in the near term. But in the current economic conditions, these are prudent decisions, while allowing us to comfortably address our dividend in the near term and position us well for growth as the macroeconomic environment improves. I look forward to the opportunities in the fourth quarter and the year ahead. We will stay laser-focused on driving strong operational and financial performance in the business environment that develops, while also positioning our company for future success. Thank you.And we'll now open it up for Q&A.

[Operator Instructions]. First question is from the line of Mike Leithead with Barclays.

Charles, congrats again on your upcoming retirement.

Thank you very much, Mike.

I guess first on Specialty Black. Can you maybe just talk a bit more through the moving pieces that drove the improvement in GP per ton this quarter? I think you'd mentioned better mix. But maybe just a bit more color on the areas where you're seeing better growth versus others as we sit today.

Well, so I think, first thing to keep in mind is, a year ago, in all openness, we had a relatively weak. So in that sense, through this quarter, we had a favorable comparison to it. And so I wouldn't say necessarily from trend lines that we've seen thus far this year, we saw a dramatic shift in terms of specific end markets for us at this point. Indeed, what we would say is, broadly speaking, Specialty was just suffering from the economic environments broad-based across most of the end markets that we serve. Charles, I don't know if you want to add anything to that?

No. I think that's right. I mean the - we - as you said, the key point is the comparison with last year. It doesn't indicate anything more than that.

Got it. That's helpful. And then second question, just on Rubber Black pricing. And I fully understand you won't talk about actual forward numbers or 2020 negotiations here. But if I just look at the business, there's really no new supply coming online in the western industry. The cost pressures on your business seem to be growing through IMO and feedstock differentials, EPA spending, all that stuff. So is it logical to just assume that pricing should accelerate over the next few years to sort of compensate for those factors?

Well, that's definitely our position. And that's what we are saying to our sales teams and to our customers that this is an industry that needs to get to cost of capital pricing, needs to have the ability to pass-through energy prices positive and negative. And by the way, although differential pass-through may increase, the higher sulfur feedstock material we use in North America is going down right now. So for the end customer, those two things largely wash. So it's not that big an asset that we're going for. But our view is, yes, very much so, that these prices should continue to move.

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

Just want to echo my congratulations, and thanks to Charles for all the help over the years, and welcome to Lorin as well.

Thank you.

So just - I was wondering if you could provide more color regionally in terms of some of the volume trends. I mean you talked about weakness, Europe, Asia. How strong were volumes in North America, or perhaps, how much better were they relative to the other regions?

So let me maybe answer it. If we just - we're going to look at, for example, loading to get us started on this. Loading in our facilities around the world, largely in the - let's say, the 80s range, floating up and down a little bit specifically where perhaps you're doing a build for an outage or a drawdown around an outage. In terms of the environment, if we're going to speak about momentum in the markets, I think it's fair to say there's a slowing across most regions at this point, certainly for Specialty. Generally speaking, I'd say rubber is held up better in the U.S. than other markets. And we - a little bit because of our customer mix, we're little bit less impacted by the GM strike than others. And Charles, would you like to anything too?

No. No. Nothing.

Okay. That's helpful. And just kind of back to Specialty margins briefly and specifically around mix. If demand was, say, flat next year, is there a scenario where mix improves enough where margins or profits per ton actually lift up? Or would you need to see, actually, demand to increase in order to get that to see a meaningful improvement?

Well, so the mix really turns on the various end markets we serve. And I think the key point on the whole Specialty businesses is, it is built around where you've got a particular - in our case, Carbon Black structure that does something unique and specific for this particular application. So in coatings, it's not just - that it disperses or it's got a high jetness, maybe they want a specific undertone. And that's a variable - valuable value adding material for them. It's perhaps meaningless in some other applications. And so certain applications, we add more value so we get more profitability. So with those ones move - see more demand, then we do better with them.So if I just move beyond automotive, which a lot of the talk is around, if we're going to say other coatings, protective, marine coatings, decorative, engineered plastics, the majority of which are not in an automobile. Fibers, printing, areas like toners or packaging, food grade. Those are like a variety of different end markets all of which would give us an uplift in terms of our GP per ton. And I list them just because they are fairly different segments of the economy but there's ones where we're able to add more value. And maybe the final point is, those are things that would move that. But we do continue to support the growth of our Carbon Black into Specialty markets that are below our average GP. There's still good business for us there, accretive in the EBITDA, they are more attractive than rubber. There are good things for us. And yes, they cause some dilution but we shouldn't lose sight that it's positive EBITDA growth for us.

The next question is from the line of Jon Tanwanteng with CJS Securities.

Pete Lukas on for John. Can you just talk about your - expand on your cash flow expectations for next year? How much flexibility is there in CapEx? And what are other sources of cash improvements that are out there?

So our current plans for next year are going into it with a pretty lean capital budget, so that we're prepared for really whatever 2020 comes up to us. And so that means deferring some things and items like that. In terms of growth CapEx, that's really not a big deal for us right now in the current economic environment. I don't see it. I just stress, we've got five more quarters of heavy EPA spending, we can absolutely do that. We can shift around our capital spending as we needed. It's not that long.

Great. And last one for me. Can you talk about your implementation of adjustors to better reflect your input and selling price differentials? And have customers been receptive to that?

So Pete by this I think you mean, for example, moving in with the surcharge for the differentials and so forth. So first we have that structure in Europe today. So really, we're just trying to modify that structure to work for what we have in the U.S. And I'd say, our - it's all commercially sensitive because we're in these negotiations right now for 2020 pricing. But I'd say, I - we expect to get that.

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

Two related questions and then just a clarification. With respect to sort of the pricing initiatives, what kind of feedback are your customers giving you on each side of the business around the sensitivity of demand that they are seeing? I mean that is - is there a price point where they are worried about demand destruction? And how is that feeding into your discussions with larger customers to try and shift to a more return on capital-based model? And I guess another clarification is just the working capital, have you seen any impact on your working capital because of the differentials? Like - so is your working capital being a little bit less responsive to the benchmarks that we might be eyeballing?

Okay. So let me start on the first part. So we are in the middle of these contract negotiations. So it is commercially sensitive to say a lot. But let me give you the sense that I give our teams and kind of how we see that playing out. Well, I tell my - our teams is we need to think of ourselves as an airline. An airline that has just a few seats left. And in that kind of situation, you're going to sell those at full fare. And I don't just mean f-a-r-e, also fair, f-a-i-r, because all we're going for is return on capital and pass-through of feedstock. And I am okay. If this means we have a few empty seats on our planes, so to speak, that is all right. And I think that's an important message for our team. Now in a specific market and a specific route, if we stay with airline analogy, if we find that we've got too many open seats we're going to have to adjust our strategy, that's what we're going for, that's how we're thinking about it.When we talk to customers, I would say, the discussion is more around the fairness and the competitive situation, more that this is really pricing them out of their specific end market. I don't think that what we're trying to do is having that effect and that message with them. In terms of the long-term contracts, that's something we remain very interested in. I think it's the right thing for this industry. It gets us to a better place. Right now most of our negotiating effort is just on these - the 2020 pricing. We do continue discussion with customers, as recently as a couple of weeks ago. I had a very senior-level meeting with one customer talking through the issue through. But most of the focus right now is just on, okay, traditional 2020 pricing. Charles, do you want to respond to the working capital?

Yes. I think your question, Laurence, is are the differentials getting tied up in our working capital through the price of feedstock. The answer is, yes. But it's not that material. And I'd say, good point to remind that in 2017 and '18 we tied up nearly $19 million in working capital. And year-to-date, we're about breakeven on working capital. And so if the economy were to soften, we would certainly still expect to recover that or most of that from working capital. And indeed, we should start to see that pretty soon. We should start to see some of that coming out in Q4. So the point, I think most important to understand is that the strong cash flow performance we've had in this quarter and indeed year-to-date, isn't through working capital, it's through managing the businesses, calling outlined. And that working capital benefit is still to come.

The next question is from the line of Kevin Hocevar with Northcoast Research.

I'd like to also extend my congrats to Charles on a nice career and your luck in the retirement.

Thanks very much, Kevin.

On the differentials. I think in the slide or in your press release, you mentioned expectation that differentials here would stabilize at current levels in the fourth quarter. So does that imply like another 5.5 or so million headwind? And what type of visibility do you - I guess what would be driving that stabilization because it does seem like it's gotten worse throughout the year? And what type of visibility do you have there to give you confidence that it'll kind of stabilize here going forward?

Well, so just in terms of our ordering patterns and how we do it. I mean at this point, just looking out really two more months, we've got a very good idea of what that's going to be and of some that material has already really been committed for. And I think what we've just seen is that supply and demand around the CBO market that perhaps it hit a point where it just stabilized based on those factors.

Got you. Okay. And so then, it looks like that will be $18-or-so million headwind for the year assuming the fourth quarter similar to the third. So is the goal then - with the surcharge and things that you're implementing, is the goal then to recover that? It was a big headwind this year. Is the goal to then recover what the - 2019 headwind in 2020 to get you back to 2018-type levels? Is that the ultimate goal here with the initiatives that you have out there?

Well, I would say, the ultimate goal we're going for is to get this business to a return of capital pricing. And that's what needs to happen to meet the supply and demand challenges. As you look forward, that's what needed to get reliability in the systems. And certainly, you're very right, we're just trying to get to a number. And if you look at our price increases that we announced, $0.08 for rubber, $0.07 for Specialty, that's - that - all of that moves us in that direction. I mean the industry I think has traditionally had an annual increase. And then over the course of the year a certain amount of differential creep. And then the next year, they would do a reset and a reset. I think the best way to understand this is, we just need to get this industry to its cost of capital. That's not a big ask, that's how most of the world works.

Makes sense. And then in terms of the EPA-related costs that you're incurring this year and next year, are those all for the most part capitalized cost that is going to through that CapEx number that you've talked about? Or is there any meaningful pickup you expect in operating costs, as maybe some of those plans become compliant?

Yes. That's a good question. So when we talk about those headline numbers, we're talking there about capital. We do have higher operating costs associated with it. And that's really the basis of the EPA surcharge that we put in place. EPA surcharge just really about operating capital. Capital is the numbers we're disclosing and that's a separate issue.

[Operator Instructions]. The next question is from the line of Jeff Zekauskas with JP Morgan.

So the Specialty Carbon Black market has contracted this year. When do you expect it to stop contracting? Or can you not tell? Is it contracting in the fourth quarter versus weak comparisons year-over-year?

So Jeff, that's an excellent question. And let me just say, when we think about 2020, and of course, we're not giving guidance for 2020 and that sort of thing. I'm not planning on a recovery in Specialty volumes. I think this is going to turn over all those end markets but those all a little bit right now rising and falling with the overall economy. I think that's a tough thing to predict. But I think we still see the impact of a weakening economy.

So are we continuing to contract in the fourth quarter, and is that your expectation for the beginning of 2020?

So I think we - with - our - let me say this, our expectations for the fourth quarter are in our guidance. You always see sequentially weaker fourth quarter, right? And we would. But I would say, in general, we do expect a more or less on par, but not - it wasn't really a great fourth quarter last year.

Can you compare price and demand conditions in China to price and demand conditions ex-China? I realize China is not the largest market for you, but it's not the smallest either.

Yes. Thank you for that. So let's recognize that our participation in China in rubber is largely in MRG. So we just have less exposure to the whole tire situation there. I would say rubber and MRG, both challenge in that market. In China, in the Specialty, it depends to a certain degree on what the end market is and then how it's affected by things, area like fiber, which is an important market for China and one which is, let's say, the Specialty market of which China is the largest. I'd say there's both volume and competitiveness issues there. We export some product from the United States for that market into China. So we, of course, see the whole tariffs situation that makes that a challenging one. But at the same time, it's a highly differentiated product and that gives us a little bit of stability in what we could see in that space. I would say, if we think about some other highly differentiated markets and those tends to be the ones we're in, in China. Pricing there has held up comparatively well.

And then lastly, on your SG&A expense. Your SG&A expense was really sharply down year-over-year, maybe I don't know, $9 million and it's under $50 million. Were there various onetime items in the SG&A line? Or are we now below $200 million annually for SG&A expense?

So I mean one element of that is just FX, okay? Another one is that with volume goes distribution and that's in our SG&A. And so that's a piece of that as well. Charles, anything you'd like to add?

Yes. There's some bonus accruals that vary year to year.

I see. So there's some lower incentive comp expense that's built into that?

Yes. Absolutely, in a year like this.

Our next question is from the line of Chris Kapsch with Loop Capital Markets.

I appreciate the additional analysis on...

Chris? Chris? We can't hear you, Chris?

Chris' line disconnected.

All right. Do we have any other questions in the queue?

No other questions at this time.

Okay. So let's hold a moment to see if Chris is able to dial back in. Okay. I guess this is not going to work out for Chris. So - well, sorry for that. We'll look forward to hearing from him separately. So I just like to thank everyone for taking the time to be with us today. And we appreciate your interest, and for all of our investors listening, we appreciate your investment and look forward to Q4. Thank you, all, very much.

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