Greetings, and welcome to the Orion Engineered Carbons Third Quarter 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Wendy Wilson, Head of Investor Relations and Corporate Communications. Thank you, Ms. Wilson. You may begin.

Thank you, operator. Good morning, everyone, and welcome to Orion Engineered Carbons conference call to discuss our third quarter 2020 financial results. I'm Wendy Wilson, Head of Investor Relations and Corporate Communications. With us today are Corning Painter, Chief Executive Officer; and Lorin Crenshaw, 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 the call. Before we begin, I'd like to remind you that some of our comments made on today's call 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 6, 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, Wendy, and good morning, everyone, and welcome to our third quarter earnings conference call. I don't want to let this moment pass without thanking our people for their dedication and flexibility during the second quarter downturn and subsequent demand surge. Most importantly, they have kept up COVID-19 safety protocols, and we have had no workplace transmission of the disease. Thank you for your focus, flexibility and dedication. I'd also like to specifically congratulate the employees involved with the various upgrades of our facility in Borger, Texas. The upgrade of the cogeneration facilities at that site allows us to run the plant without drawing power from the grid while still providing excess energy back to the regional grid for use in the local area. On today's call, Lorin and I will cover the third quarter results and also devote time to pricing negotiations for 2021, our operational response to COVID-19, select leading indicators of recovery that may affect the business and examples of initiatives that we have undertaken to emerge stronger. As always, we will be happy to take your questions at the conclusion of our comments. Turning to Slide 3. Third quarter demand for carbon black recovered rather well versus the historic low experienced during the second quarter. In most months since April, we have seen rubber carbon black demand improve across all geographies, and specialty carbon black has recently improved as well. While we cannot predict the future course of the pandemic, our year-to-date financial results demonstrate our ability to withstand its ups and downs. From a financial perspective, we reported adjusted EBITDA of $55 million, down 19.2% year-over-year and more than triple second quarter levels sequentially, reflecting the substantial operating leverage we expected the business to deliver as the economy recovered. Also note that on a…

Thanks, Corning. Now turning to Slide 8. Volumes were down 7.6% year-over-year but rose 51% sequentially on higher demand in both segments and across all regions. Against this backdrop, adjusted EBITDA more than tripled to $55 million. Basic EPS came in at $0.15 per share, and adjusted EPS was $0.32 per share. Contribution margin declined 12.7% year-over-year, primarily driven by lower volume but increased 59% sequentially. Overall, each division showed strong operating leverage with incremental margins adjusted for the impact of FX and oil on revenue and profitability in line with or better than expected with specialty exceeding the mid-40s plus range due to mix and rubber in the low to mid-30s range. Slide 9 explains the drivers behind contribution margin, adjusted EBITDA and net income in greater detail. Starting at the upper left-hand side, contribution margin declined 12.7% year-over-year as lower volume, the impact of lower oil prices on margin and unfavorable mix in specialty partially offset base price improvement in both segments. Adjusted EBITDA fell 19.2% year-over-year to $55 million, reflecting the decline in contribution margin. Lower costs cushioned the impact somewhat, driven by a favorable VAT settlement and lower discretionary spending. Finally, we recorded net income for the quarter of $9 million, down year-over-year, largely due to lower adjusted EBITDA. Slide 10 details the year-to-date sources and uses of cash. As expected, working capital rose during the quarter, primarily driven by higher accounts receivables resulting from a sharp sequential sales increase. Notably, this surge-driven working capital increase was the primary factor preventing us from showing positive free cash flow for the quarter. Overall, as Corning noted earlier, from a cash flow perspective, we are pleased that, on a year-to-date basis, despite the severe second quarter downturn and continuing to advance our EPA investments, our business is only…

Thanks, Lorin. Moving to Slide 16. We've reinstated our EBITDA guidance for the fourth quarter barring a further downturn in economic activity, and that could happen with rising COVID-19 infections. We expect adjusted EBITDA to be in the range of $44 million to $54 million, which is roughly 10% lower sequentially. With that being said, our fourth quarter order book is constructive. The range of our guidance reflects the fact that, historically, December is hard to predict, especially in a year like this, and the fourth quarter is typically our weakness. It's also difficult to gauge the extent to which the recent decline in mobility data is reflecting normal seasonal declines as the summer ends or whether other factors are in play. Our 2020 capital forecast remains in the $140 million to $145 million range with the upper end of the range increasingly likely as we execute a variety of safety, reliability and productivity projects that will position us to emerge stronger heading into 2021, as noted in our previous earnings call. Our best estimate of the cost of the U.S. air quality investments remains $250 million, plus or minus 8%. As we've shared previously, we expect approximately 50% of this cost to have been spent between 2018 and the end of this year with the remaining 50% spread between 2021 and 2023. We completed our first EPA project in June at our Orange facility and remain focused on executing the work at our Ivanhoe facility as rapidly as supply issues and the physical distancing required to safely advance the work will allow. We continue to communicate our intentions and projects scheduled to the EPA on a monthly basis as we have done since we first declared force majeure. Turning to Slide 17. In closing, I'd like to highlight a…

[Operator Instructions] Our first question comes from the line of Jeff Zekauskas with JPMorgan.

Can you talk about some of the negative mix factors in the quarter? Your volumes were really not down very much year-over-year, but your EBITDA fell at a much greater rate. Can you more concisely describe why that's the case?

I'll take, Jeff, a couple of general comments and I'll let Lorin jump in. So one element on mix is in the rubber area, the issue between MRG and tire, MRG being only going into new cars and a little bit more attractive than rubber carbon Black going into the tire market. So the relative strength of replacement tires right now relative to OEM production, even though OEM recovered, that's one thing that plays into mix for us.

And I would just add, that's right on a year-over-year basis. Sequentially, in terms of our incremental margins, once you back out the impact of oil on revenue and profit, specialty actually had better mix sequentially and was right in line with our mid-40s plus incremental margin. And rubber, again, sequentially, was right in line with our low 30s incremental margins. And so I think that's right.

And I guess, secondly, so miles driven has been touched by the recession and by COVID conditions. To what extent do you think that, that affects the growth rate of the tire market over a multiyear period?

Well, there's no question. If there's going to be less driving going forward over the long haul, then there's going to be less time wear, and that would have an impact on the market if that's what you mean.

Right. I was wondering if you guys had made an attempt to quantify that given current conditions or one can see a tendency, but one can't really do much more than that.

Yes. I think right now, I'm drawing conclusions from the current COVID-19 not being behind us. As I said in the script, I mean, I think there's going to be more working for home. I think there's going to be a stronger preference for cars over other modes of transportation. And I think we've just got to get a little bit of time to see where that balance is going to come out.

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

I guess, first, if I look at Slide 6, which I think is really helpful, by the way, it looks like rubber black is a bit more of a -- leading with the recovery, whereas specialty is a bit more concurrent in terms of economic factors. And then if I look at your volumes this quarter, rubber is down about 9%. Specialty is down about 3%. So can you maybe parse through why specialty was a bit better than rubber volumetrically this quarter, and with that, maybe how the different end markets -- demand trends you've seen there in specialty?

Yes. So I think what we're trying to reflect is that we thought the first thing to bounce is where that green checkmark is in the replacement tire, and that is the first thing we saw bounce. And we did see Rubber Carbon Black come back sooner than we saw Specialty Carbon Black. It turned the corner sooner, let's say. But no question, Specialty Carbon Black has come back overall at this point to a higher level compared to last year, and that reflects just across a wide range of end markets. And in general, many of those have improved, even areas like pipe, which I've talked about before, although I suspect that a portion of that, let's say, oilfield services is going to still impact infrastructure and other activities, in other regions of the world, that continues to do well. Probably star areas in the specialty area would be anything related to food, food packaging, that kind of thing, in the current environment, with all the carryout, is quite strong. Things like ink for printed materials, that's an area of weakness in the market today.

Great. That's super helpful. And then, Corning, any early indications about how you're feeling about base pricing heading into next year? And relatedly, you've talked in the past about trying to improve or restructure the contracts in the industry. My guess is COVID got a little bit in the way this year of doing that. But do you still think that's achievable maybe in the next 2, 3 years?

Okay. Yes. So for 2 of those things. If I start just with a sense of pricing, I think one really critical thing about pricing is that this whole industry was tested this year during this downturn. I'm really happy to say being relatively new to the space that rubber carbon black pricing, the contracts held and really weren't even challenged. I think that's a really positive thing for us. And if you look at our behavior over the year -- or through this year, I think the same thing is largely said about specialty, although the contract structure there is differently. In terms of talking about 2021, you have to keep in mind that our customers are listening to this as well. So let me just share a couple of observations. Number one, the customers we're working with for the tire market primarily we're talking about now, they have pretty different scenarios of what they think 2021 is going to look like. And I think that reflects the overall uncertainty in the market. But it's an interesting negotiating dynamic going on right now. And the second thing I'd say is given that and given the limitation of the ability to store material, I'd say in a dynamic market like this with the potential for surges, and we don't know how COVID's going to play out next year, capacity -- having capacity is a valuable thing in my opinion. Beyond that, I'd just say, look, the long-term drivers for pricing in the carbon black industry is still with us. There's still increasing capacity of rubber, of tire manufacturing in the United States. There's now increases in carbon black. I mean the trend there is still with us. In terms of long-term agreements, we are actually still in discussions with certain players. I think there's people who see that as a full way of thinking and a good win-win for everybody involved. You're right. COVID-19 does complicate things this year, but we continue to discuss with people. It's all talk until we have it done. But I continue to think it makes sense, and there are some parties in the industry who remain interested in it.

Next question comes from the line of Josh Spector with UBS.

Just coming back to specialty volumes, pretty impressive performance in the third quarter. Wonder if you could quantify how much of that may have benefited from restocking and how much of that was maybe more normalized demand. And maybe a related question around that is what are the volume scenarios that you're baking into your 4Q guidance around specialty.

So it is difficult to tease out, and we made some comments of that in our script. What's restocking? What was pent-up demand from when things were locked down? And that's hard to gauge. If we think about automotive, there was a hard stop in auto manufacturing for the period of time. Everybody wanted to burn through inventory. If you bought a car recently as I have, you can see there's very few cars on the lot right now, so they're still a little bit in catch-up mode. So I would say, I don't think we're necessarily seeing steady state at this point. Our guidance is based largely on the current forecast that we have from our customers, so taking that as the primary versus guessing where they are in their inventory and then with this kind of open question mark about what's December really going to look like. And I think our customers wouldn't claim to have a great deal of insight exactly what's going to happen in that market.

And Josh, I would just add that if you look at the midpoint of our fourth quarter guidance, I don't want to get into specialty versus rubber. But if you look at the midpoint and you just think about our typical EBITDA per metric ton, it implies that we're expecting about a 10%-ish sequential decline in volume, and that's true across both businesses generally speaking.

Okay. Fair enough. And I guess, if I look at rubber profitability for the quarter, EBITDA was around $160 per ton. If I assume oil is still kind of constant in the low to mid-40s and maybe some of the other pricing factors have removed that as well, is there anything I should add or remove to that when I start to look at maybe first half next year assuming volumes are still down 10%? So just trying to think if there's anything temporary within the quarter that we should remove or anything that we should add back into a more sustainable recovery.

I would say that once you make an assumption on oil on average for next year, which we've provided some guidance on how to think about that, the main thing you ought to consider is that we've accomplished about $15 million of cost reductions this year, but only $3 million of those are going to be permanent. And so you should anticipate an increase in S&A for that delta, and that would flow between both businesses. And so that's the main -- to think about 2021, that's the main thing I want to make sure that you consider.

Maybe one more clarification around that. So the $15 million, can you clarify how much you maybe benefited this quarter versus last quarter?

Yes. I'm not prepared to break that $15 million down in terms of the impact this particular quarter. But as you look at 2021, yes, I'd just ask you to consider that.

Our next question comes from the line of Jon Tanwanteng with CJS Securities.

It's Pete Lukas for Jon. You guys have covered most of my questions. I guess just one on gross profit per ton. In either segment, do you think that we've reached a trough there? And if not, when would you expect to see recovery there?

Well, I mean, a lot of the impact has been volume. And so I think what you're really kind of getting at is are we seeing a trough or did we see in the prior quarter a trough on volume. I certainly hope so, and that's certainly how things look right now.

Great. That's it for me. Most of the others have been answered.

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

Obviously, the tire industry wasn't the only one impacted by COVID, but the refining industry, in particular, was -- has been impacted by lower miles driven, demand disruption for gasoline and kerosene. And so I'm just curious if -- with that industry's pressure that's seen, has that affected at all your availability of feedstocks? And notwithstanding the IMO 2020 regs that everybody's sort of no longer focuses on, I'm just wondering if it's resulted in any changes or opportunities with respect to your differentials in sourcing feedstock.

Yes. So I'd say the ability to source feedstock is really unchanged, so we have no problem with that. I think it's slightly commercially sensitive what exactly we experience in differentials. I'd like to hold on that.

Okay. So the other question I had was -- and I appreciate the details on the profitability metrics and differentials on a sequential basis. But curious, the -- I forget what your cost accounting is. I'm curious if it's FIFO because if it is, as I understand that, there would therefore be some -- maybe some sequential drag on the profitability metrics to the extent you're selling inventories that were produced when your utilization rates were lower. So I'm wondering if that's dampening the -- even though they obviously improved nicely, the margins in the second -- I'm sorry, in the third quarter vis-à-vis the second quarter, were just dampening margins because of that -- because of your cost accounting period.

Yes. We have not had that sort of dynamic. We did experience something of that sort during the teeth of the crisis earlier in the year, but that was not an impact on the quarter. The main drag from an absorption perspective was simply the fact that our utilization rates year-over-year were lower, although we did find, in terms of sales volumes in the 90s year-over-year, our operating rates were not in the 90s of 2019 levels. And so that was the main driver.

Okay. And then one last one, I guess, is a little more nuanced on -- as you completed some of the EPA investments or as you work through that, is that -- will that -- effectively with your -- the scrubbing that will be in place, does that change the flexibility that you'll have in terms of sourcing different feedstocks? Will you be able to opportunistically use effectively higher sulfur feedstock since you can abate the SOx associated with combusting those feedstocks? Is that effectively a sort of hidden benefit of these investments?

Chris, I just want to acknowledge on that question, there's a lot of things in play including questions between ourselves and Evonik and all of that. So let me just say that, once you put in the abatement equipment, you're now tracked on what your actual emissions coming out of it are. And let me just leave the answer there, which I think gets to it.

[Operator Instructions] Our next question comes from the line of Kevin Hocevar with Northcoast Research.

I wanted to make sure I was understanding something correctly. Lorin, I think you just mentioned in the fourth quarter guidance, it seems to imply the midpoint kind of 10% quarter-over-quarter decline in volumes, and I think you mentioned that's kind of similar for both businesses. And then on one of the slides has mentioned that October utilization rates are up year-over-year versus the prior October. I think that's what that's saying on Slide 4, which seems to imply volumes might be up in October. So I guess I just want to make sure I'm understanding that right because, I guess, volumes down 10% sequentially would imply volumes down something year-over-year. And again, that October comment seems to imply that volumes are up unless you're building inventory or something. But curious if you could help me reconcile kind of what you're seeing in October versus what's implied in that guidance.

Sure. So the key uncertainty around the next 60 days is really with regard to our customers and how they choose to position themselves. And so 1 month does not make a trend. And so yes, October has been very solid, but -- and that might take us towards the higher end of our guidance. But we just don't know how the next 60 days are going to transpire. And so that's how you end up at the midpoint.

Okay. Got you. And then you guys mentioned the expectation is -- I think Corning mentioned in the prepared remarks that we wouldn't return back to 2019 levels of demand until -- for another 12 to 18 months. So curious what that implies for 2021. Does that -- obviously volumes, I would imagine, will be up quite a bit year-over-year, but it sounds like down something versus 2019. So that does not imply we're within 5-ish percent or something from 2019. Just kind of curious what -- if you could just give a little more color on that comment in terms of what that implies for volumes over the next 12 months or so.

Yes. So I think one answer on that, I mean, if you were going to look for just independent data, you can look at what the Notch data is suggesting, which is saying that more or less on par with 2019, and then they -- various scenarios from there. If we were going to look at forecasts from customers, as I said earlier, that's a bit up and down themselves amongst different customers as well. So as you would expect, there's a certain amount of uncertainty for exactly what is going to happen but certainly the volatility dampening down considerably compared to where we were this year.

And I would also add that who knows what Notch is considering, but it's really important to have an assumption around will we have a safe, effective, widely distributed vaccine in 2021. And that's a key question that is difficult to know. But I'd just throw that out there.

I think that also just plays into the whole commercial dynamic because people are essentially right now negotiating for reserve capacity. And you could be in a situation where, I don't know, halfway through the year, a quarter of the way through the year, I mean, at some point next year, I think we're going to get that vaccine. And people are going to want the capacity because I think we'll see quite a bit of uptake in the economy when that happens. So it all adds for just a very exciting and interesting time right now but a time that we are very well prepared to take care -- take advantage of, to use the volatility and to perform well in this environment.

[Operator Instructions] Our next question comes from the line of Laurence Alexander with Jefferies.

Could you give -- discuss CapEx from a slightly different angle? How much could you grow the top line or grow volumes before you need to undertake your next significant increase in CapEx spending?

Well, that's an excellent question. And so our opportunities there is, number one, well, we've got about 1.1 million kt of capacity. So you can look at where sales come out and say, okay, there's an opportunity there and use the guidelines we've put in for how to look like that would turn out as an incremental margin for us. Beyond that, we clearly have the project underway in Ravenna. So that gets us some added capacity slated towards specialty with some differentiated rubber in that. And there's also the opportunity to, let's, repurpose a lot of the capacity that we have in there. Beyond that, though, you are looking at additional capacity.

And let me just add, Laurence. If you accept that 1.1 million is our maximum and you annualize what we're doing today, volume-wise, you get to about 840. And that would imply about 30% growth to our max utilization.

We have reached the end of our question-and-answer session. I'd like to turn the conference back over to Mr. Painter for any closing remarks.

Well, thank you, again, everyone, for joining us today, and we appreciate your attention and your interest in Orion Engineered Carbons. Once again, thank you to the Orion team for their great performance in this quarter, working diligently to keep up with just surging demand from our customers. Thank you all. And to our shareholders, we appreciate your support and are doing our best for you. Thank you very much.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.