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…

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…

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…

[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.