Jan 31, 2013
Executives
Erica McLaughlin – VP IR Patrick M. Prevost – President and CEO Eduardo E.
Cordeiro – EVP and CFO
Analysts
Kevin Hocevar – Northcoast Research Partners, LLC Ivan M. Marcuse – KeyBanc Capital Markets David Begleiter – Deutsche Bank Securities, Inc.
Laurence Alexander – Jefferies & Co. Christopher W.
Butler – Sidoti & Co. LLC Jay Harris
Operator
Operator
Good day ladies and gentlemen, and welcome to the Q1, 2013 Cabot earnings conference call. My name is Sue and I will be your operator for today.
(Operator Instructions). Now I would like to turn the call over to Erica McLaughlin, Vice President, Investor Relations.
Please go ahead.
Erica McLaughlin
Thank you, Sue. Good afternoon.
I would like to welcome you to the Cabot Corporation earning's teleconference. Last night, we released results for our first quarter of fiscal year 2013, copies of which are posted in the investor relations section of our website.
For those on our mailing list, you received the press release either by email or fax. If you are not on our mailing list and are interesting in receiving this information in the future, please contact investor relations.
The slide deck that accompanies this call is also available in the investor relations portion of our website. And will be available in conjunction with the replay of the call.
I remind you that our conversation today will include forward-looking statements, which are subject to risks and uncertainties and Cabot's actual results may differ materially from those expressed in the forward-looking statements. A list of factors that could affect Cabot's actual results can be found in the press release we issued last night and are discussed more fully in the reports we file with Securities and Exchange Commission particularly in our last annual report on form 10-K.
These filings can be found in the investor relations portion of our website. I will now turn the call over to Patrick Prevost who will discuss the key highlights of the company's performance.
Eddie Cordeiro will review the business segment and corporate financial details. Following this, Patrick will provide closing comments and open the floor to questions.
Patrick.
Patrick M. Prevost
Thank you, Erica, and good afternoon ladies and gentlemen. Considering the year's difficult economic environment and the extremely weak Specialty Fluids results, we none the less delivered improved performance this quarter.
Compared to the fourth quarter of fiscal 2012, Specialty Fluids results decreased by $11 million. Although it is our highest return business and has good long term growth potential, the quarterly variability led to the business earning only net $1 million of EBIT this quarter.
On the positive side, we experienced 25% higher volumes year-over-year in our Fumed Metal Oxides business from the introduction of new products and the utilization of our new capacity in China. The addition of purification solutions, restructuring cost savings in advanced technologies, and the improved performance in the last American deposits were also positive contributors to the improvement year-over-year.
Unfortunately, offsetting these positive contributions was a weak economic environment that negatively affected our volumes and capacity utilization in reinforcement materials and specialty carbons and compounds. We continue to experience weak tire production around the world, which caused our elastomer volumes to decline 3% as compared to the same quarter last year.
Specialty carbons and compounds experienced a weak December as inventories at our customers were drawn down for year end. In addition, the U.S.
coal fire utility market continues to be challenging due to low natural gas prices and low electricity consumption, which caused a decline in volumes to the gas and air end markets as compared to the same quarter last year. The improvement in Elastomer Composites is a result of the receipt of the planned milestone payment and royalties related to our technology licensing agreement with Michelin.
Since 2008, Cabot has been working with Michelin to develop the technology in manufacturing operations necessary to commercialize CEC in global tire markets. Through this agreement, Michelin has exclusive rights to Cabot's Elastomer Composite process technology for tire applications.
And is entitled to build and operate plants. We have now entered into the next phase of this agreement with receipt of royalties, which extend through 2022.
This royalty agreement is a continuation of a prosperous and long term relationship with Michelin as well as a significant business opportunity for Cabot. Cabot's Elastomer Composites technology enables new tire design opportunities for Michelin to improve tire performance.
The agreement highlights Cabot's history of creating value in the tire industry with new and innovative solutions. Moving to our most recent addition, with six months of ownership of Norit under our belt, I thought I would take the opportunity to give you some of my views on the business and the activated carbon industry.
First, I'm more confident than ever that the overall basis for the acquisition is well founded. The business fits with our other specialty businesses like Fumed Metal Oxides and Specialty Carbon even more than I had thought leading up to the acquisition.
It supports our overall strategy to be a technology and industry leader with businesses that have high margins and stable earnings. Similar to the rest of Cabot, Purification Solutions is a technology leader at modifying the surface area and chemistry of carbon to customize solutions for its customers.
The business serves a diverse set of high growth markets through its proprietary process technology enabling us to produce a significant number of high value products. With more than 150 formulations of activated carbon sold, there is significant differentiation among the products for a wide range of applications.
Purification Solutions marketing, application development, and selling activities are closely related to the way we deliver our value added products in our performance materials businesses. Our Cabot technical teams are pursuing early opportunities to help Purification Solutions with new products in the mercury removal and automotive industries.
At the same time, we anticipate activity of carbon may be an additional solution for some of our specialty carbons and Fumed Silica customer challenges. Although we're experiencing near term weakness in the North American coal fire utilities market, our overall growth thesis is still very much intact.
And a number of activities that have taken place in the last three months confirm that federal regulation will commence in 2015. With the re-election of the current administration last November, we believe the regulatory efforts to control mercury in the United States will be strengthened.
Having met a number of our key customers in this area, it is clear to us that they are ramping up for implementation in 2015. We also believe there is substantial upside in the mercury removal area and other regions, including China, India, and Europe where coal is a key raw material for power generation.
Just this month at a global United Nations conference in Switzerland, 140 nations agreed to rules called the Minimata Convention, which will control mercury emissions on the global basis. The integration of Norit has been very successful so far.
As events fired in due diligence, the Norit and Cabot cultures are an excellent fit. I believe this is because our business models are very similar.
The culture fit has made it easy for both sides to work together and move the integration forward quickly. I've met regularly with the business teams.
And we have already made changes to maximize long-term success. Importantly, key Norit business leaders have been retained.
One change we have made was to appoint Fred von Gottberg as the General Manager of the business. Fred is a long term Cabot senior executive who has a great deal of experience in high growth technical markets.
Fred's most recent position was as General Manager of the advanced technology's new business group. I have also added two high level resources to the organization where I felt we needed additional strategic focus, a leader of the coal fire utility business and a leader for the Asia-Pacific region.
There are a number of key functional areas such as engineering, purchasing, human resources, and finance that have also been strengthened with Cabot's support. And beyond the commercial and technical synergies, we have also identified more cost synergies than we had originally anticipated.
And we're implementing the systems and processes needed to achieve them. As I mentioned before, we continue to believe that the growth opportunity for the U.S.
coal fire utilities market is significant due the mass regulation, which will be effective in April of 2015. However, the current demand's activated carbon continues to be affected by a lower power consumption and very low natural gas prices.
Power generation in the U.S. from coal fired utilities has declined from roughly 45% of total U.S.
power generation in 2011 to approximately 38% in 2012. Industry experts project that U.S.
coal fire power generation will retain this share level for the next ten years. At the same time, the activated carbon industry has added capacity in anticipation of the 2015 mass regulation resulting in near-term competitive pressure.
However, by 2015, we believe the industry will be in a situation of significant shortage. We were well aware of these supply and demand dynamics when we bought the business.
And recognize the key strategic question for us. How will we navigate from an industry dynamic of excess supply to a situation where capacity is short?
We have permits to expand our North American capacity in Texas and Canada in order to meet the expected demand growth. We are ready to add new capacity.
That will only happen as soon as we have sufficient customer commitments. To strategically position ourselves for the next few years, we're taking a few steps in 2013 that will impact this year's results.
The first is that we're reducing inventory levels in order to better manage our supply chain. The second is that we're taking commercial steps through contract negotiations to maintain our market share leadership position in both equipment systems and activated carbon despite the challenging environment.
We believe this will position us well for when demand increases. And finally, we're adding commercial and technical resources to insure we have the proper kept capabilities to succeed.
The combination of these items results in our expectations for 2013 accretion to be approximately $0.15. But we expect to achieve our original accretion estimate in 2014 of $0.40 to $0.50 as growth accelerates.
Despite the near-term challenges, the coal fire utility market continues to have tremendous long term potential, both in the U.S. and globally.
The strength of Cabot in Asia will accelerate purification solutions sales growth in that region. Beyond the mercury removal market, we're experiencing solid growth for activated carbon for the water, food and beverage, pharmaceuticals, and catalyst end markets.
Excluding the air and gas purification sectors, we saw 10% volume growth in all other markets this quarter as compared to the first quarter of fiscal 2012. Our technological and feed stock advantages are driving growth demand in these areas.
We continue to be the leader in this industry. And see continued growth in many attractive end markets.
And are introducing innovative new products. I believe that the long-term potential for this segment is very good.
And expect to double the EBITDA of purification solutions in the coming five to six years. I will now turn this call over to Eddie to discuss the first quarter financial results in more details.
Eddie.
Eduardo E. Cordeiro
Thank you, Patrick. For the first fiscal quarter, total segment EBIT from continuing operations was $90 million, which was $9 million higher than last year's first quarter.
The increase as compared to the prior year was driven by higher unit margins that more than offset lower volumes. Sequentially, total segment EBIT decreased $6 million, which was primarily driven by an extremely weak Specialty Fluids performance.
Now I will discuss the details of the segment level beginning with reinforcement materials. During the first quarter of 2013, EBIT for reinforcement materials decreased by $5 million as compared to the first quarter of 2012.
The decrease was driven principally by 3% lower volumes and higher manufacturing costs, which were partially offset by improved unit margins. Due to the weak global environment, volumes declined in the first fiscal quarter of 2013 as compared to the same quarter of fiscal 2012 in all regions except China and South America.
We experienced higher unit margins resulting from our value pricing initiatives and benefits from our energy and yield projects while we continue to face a competitive environment in China where we are balancing our volume and price management decisions. Sequentially, EBIT increased $9 million driven by higher unit margins and lower manufacturing costs.
These favorable impacts were partially offset by 4% lower volumes. Volumes declined in all regions except Southeast Asia due to weak global tire production and customer inventory management at calendar year end.
The macroeconomic environment continues to be challenging. And we remain cautious about the near term.
While our customers are anticipating tire demand recovery in 2013, we believe that they will look for very clear downstream indicators before they ramp up production, therefore carbon black purchases. I also want to provide you with a general update on our recently concluded 2013 contract discussions.
You will recall that the majority of our contract business is in the western hemisphere. The competitive environment in Rubber Blacks differs around the globe.
And this is reflected in our contracts for 2013. Directionally, we have seen strengthening in North America, but weakening in Europe driven by macroeconomic conditions.
Overall for the business, we see 2013 contract pricing down marginally relative to 2012. We remain very committed to our value pricing strategy as we prepare for future demand recovery.
The construction of our new plant in China is well underway. And we anticipate the new capacity will be completed by the end of the calendar year.
Our plant in Xingtai is designed to deliver high performance carbon black products to meet China's emerging demand for higher performance reinforcing materials for tires and industrial rubber products. In performance materials, EBIT increased by $5 million as compared to the first quarter of 2012.
The increase was driven by 25% higher volumes in Fumed Metal Oxides from new product introductions and the utilization of our new capacity in China and lower manufacturing costs. These benefits were partially offset by 13% lower specialty carbons in compounds volumes due to customer inventory management in December.
Sequentially, performance materials EBIT decreased by $8 million principally due to seasonal lower volumes in Fumed Metal Oxides where volumes decreased by 5% and due to an 18% decline in specialty carbons and compounds volumes resulting from our customer's year-end inventory management. We were pleased to see another quarter of year-over-year volume growth in Fumed Metal Oxides.
In order to support growth in this business, we expanded our Fumed Silica plant in Wales where we have a fence line partnership with Dow Corning. These uncertain times appear to be causing our customers to be cautious about their inventory levels.
And it is leading to more variable bursting patterns. This variability impacts us both through the demand for our products and our ability to manage our inventory efficiently.
The weak volumes in specialty carbons and compounds in the first quarter were driven by substantial de-stocking of our customers in December. We saw a similar level of restocking in January.
And expect to see this demand recovery continue through the second fiscal quarter. Advanced Technology's EBIT increased by $2 million from the first quarter of fiscal 2012.
The EBIT increase resulted principally from restructuring cost savings and improved performance in Elastomer Composites, which had higher volumes and received both royalties and a technology milestone payment. Sequentially, Advanced Technologies EBIT decreased by $9 million principally due to an $11 million decline in Specialty Fluids profitability from an extremely low activity levels during the quarter.
While we understand the quarter variability of Specialty Fluids is frustrating, we are seeing improved activity levels as we look out for the next six months. We are pleased with our progress in Elastomer Composites.
And look forward to continuing our valuable partnership with Michelin. On an adjusted standalone basis, EBITDA for the first quarter of fiscal 2013 in Purification Solutions decreased by $3 million compared to the first quarter of fiscal 2012.
The decrease in EBITDA was driven by higher manufacturing costs and a 2% decrease in volumes as a result of lower sales to the gas and air purification end markets. The decline in gas and air purification volumes was partially offset by growth in other applications.
Sequentially, EBITDA increased $1 million as compared to the fourth quarter of fiscal 2012 driven by a favorable product mix and lower manufacturing costs partially offset by seasonally lower volumes. I will now turn to corporate items.
We ended the quarter with a cash balance of $91 million, which was a decrease of $29 million from September. The driver of the decrease was the use of cash for $62 million of capital expenditures and an $88 million increase in net working capital.
Our liquidity position remains strong at $588 million. We recorded a net tax provision of $19 million for the first quarter, which included a charge for tax related certain items at $7 million.
Our operating tax rate on continuing operations for the first quarter was 27%. We expect our operating tax rate for fiscal 2013 will be between 25% and 27%.
I will now turn the call back over to Patrick.
Patrick M. Prevost
Thank you, Eddie. Despite the uncertain economic environment, we continue to work on areas within our control, which include margin improvement, capacity expansion, new product, and business development, and the integration of Norit into our portfolio all of which will help us achieve our targeted growth.
We continue to progress our marching expansion efforts and new product launches. We have been successful at our value pricing initiatives over the past few years.
And can see the results in the margin profile of the company. During this quarter, we continued our commercialization of new products with the launch of two new specialty carbons for coatings applications and a new Fumed Silica for silicone elastomer applications.
Already in January, we have launched two more new products. One is a narrow gel insulation blanket.
And the other is a suite of performance additives for lead acid batteries. I'm very pleased with our progress to date in growing our margins and launching new differentiated products.
During this quarter, we started up new Fumed Silica capacity in Barry, Wales where we de-bottlenecked our local production by 25%. The project is an extension of Cabot's long term partnership with Dow Corning.
Our new capacity will help meet rising global silica demands for elastomer silicones, the latter of which is expected to continue to grow at 5% to 10% for year over the coming decade. This is another example of the long-standing partnerships we have with our customers.
I also feel very good about the growth of our advanced technology segment. We have already talked about the technology license agreement with Michelin for our Elastomer Composite technology.
And we're also doing very well capturing growth in Inkjet Colarants for commercial printing. Specialty Fluids has also made great strides in its' expansion of the North Sea with jobs completed in both Malaysia and India last year.
The challenging economic environment is putting pressure on our near term volume growth. We remain committed to our target of $4.90 to $5.00 adjusted EPS in 2014.
But demand recovery for our key markets in reinforcing materials and performance materials will need to occur. We need to see improvement in our [inaudible] black utilization rates, which were between 75% and 80% this quarter.
As we learned in 2009, a demand recovery can happen very quickly in our businesses. And we're well positioned with competitive capacity for when the recovery takes place.
In summary, we're seeing mixed results across our portfolio businesses. Global tire demand looks like it will remain weak through the second fiscal quarter.
We also expect the U.S. coal fire utilities market to continue to be impacted by the low price of natural gas.
In our Performance Materials segment, we have seen strong volume improvements in all businesses in the month of January. Overall, we anticipate demand to recover through 2013.
And we're well positioned to capture volume growth as a result of the investments we have made. Over the last three years, we have improved our margin structure to our pricing initiatives, investment in operational excellence, and the introduction of new products, which will continue to drive earnings growth.
Operator
Thank you. Ladies and gentlemen, (Operator instructions).
Please stand by for your first questions. Your first question comes from the line of Kevin Hocevar, please go ahead.
Kevin Hocevar – Northcoast Research Partners, LLC
Hi, good afternoon everybody.
Patrick M. Provost
Good afternoon, Kevin.
Kevin Hocevar – Northcoast Research Partners, LLC
I was wondering if you could talk about the Asian dynamics in the Rubber Blacks – you know, in the fourth quarter, it sounded like it was a $6 million head wind during the quarter. So, I’m just wondering was it similar here in the first quarter, or did things deteriorate in that region?
Patrick M. Provost
Yes, let me take the example of [inaudible] to illustrate what’s going on, and again, you know, there’s a lot of different counties in Asia – Pacific live different dynamics, but what we’re currently seeing in China is a more competitive environment than we had expected, and a lot of it is due to the tire industry situation. As we look at on road tire production in China, this – it has increased about 5, 5.5% from in 2012 over 2011, but all of this – and that’s really critical – all of this growth has actually happened in the first six months of the calendar year, and after that its been fairly much flat through the declining, and we’ve seen especially the truck and [inaudible] tire production declining strongly in the fourth quarter – so, the fourth calendar quarter, and that of course has effected the environment for Carbon Black.
So, specifically as I look at Cabot’s position, we’re running our Carbon Black plants flat out in China right now, or close to because we’re really keen on maintaining our share of the market. We believe our customers are needing us to supply their needs, especially in these times.
And as you know, we also have a plant starting up later this year and we want to make sure that that’s [inaudible] is successful. The result of that is – you know, our competitive environment has increased, so we’re declining volume – in China the local competition has grown stronger, and we have had experience prior to erosion as a result to this weaker supply and demand environment.
We believe the decision is the right one in terms of the China market still being a very high growth market in the long run, and we’re bringing up some new capacity for new products that are more in the hiring forcing area that we believe are going to be growing even faster in the China economy. So, this is somewhat a way to describe the Asian environment and how we’re responding to the current challenge.
Kevin Hocevar – Northcoast Research Partners, LLC
Okay, and could you elaborate a little further too on the contract pricing going into 2013? I know you mentioned that the U.S.
or I guess North America was relatively strong – could you elaborate on the other regions that are offsetting this where is pricing given back – is it mainly Europe? I know you said western hemisphere is where most of the contracts are, but is it mainly Europe where you happen to give back price wars, or is it other regions as well?
Patrick M. Provost
Yes, the European environment is the one that’s actually effected the contract pricing. They’re – the volumes there have stayed weak and continue to be weak, and then has effective contract pricing for 2013.
But all and all, if we look at contract pricing across the globe, I would say the result of the new set of negotiations for the calendar year 2013 is a marginal decline versus the pricing of 2012.
Kevin Hocevar – Northcoast Research Partners, LLC
Okay, and could you elaborate on how much the CEC royalty payment was during the quarter, as well as the Milestone payment?
Patrick M. Provost
Right, I – I don’t have the Milestone payment here, but I know the royalty payment was approximately $1 million, and we – and the Milestone was $1.5 million, and we – we will be continue to receive [inaudible] royalty from Michelin, and that royalty will of course be somewhat bearable because it will be linked to production.
Kevin Hocevar – Northcoast Research Partners, LLC
Okay, and just final question, could you – on specialty fluids, how – could you give us the magnitude as, you know, you said you’re seeing pick ups over the next six months – you know, got down to $1 million this quarter. Could you give us an idea of what the magnitude of the increase could be over the next six months?
Patrick M. Provost
It’s – it is one of the businesses that’s the most difficult to forecast for us, and if you go back to our reporting on this business, you can see that the swings can be dramatic. We are expecting, you know, similar swings in the future, but of course again, quarter-on-quarter we may see big differences.
Kevin Hocevar – Northcoast Research Partners, LLC
Okay, all right, thank you very much.
Operator
I’m cuing in our next question coming from the line of Ivan Marcuse, please go ahead.
Ivan M. Marcuse – KeyBanc Capital Markets
All right, thanks for taking my question. In the reinforcement business, it sounds like demand improved in January, is there a seasonal impact here, and what’s sort of your sequential expectations from first quarter to second quarter in terms of volume?
Patrick M. Provost
So let me just correct that, we’ve seen a significant [inaudible] improvement in the performance material segment…
Ivan M. Marcuse – KeyBanc Capital Markets
Oh, I’m sorry.
Patrick M. Provost
Across the board, so not in the reinforcement [inaudible] business where we continue to see, you know, the type of weakness that we’ve experienced in the first quarter – for the second quarter.
Ivan M. Marcuse – KeyBanc Capital Markets
So, in terms of total time you expect the inquiry to look similar for first quarter?
Patrick M. Provost
We – there maybe some slight improvement, but I would say at this stage we do not believe there will be, or we can’t see any recovery.
Ivan M. Marcuse – KeyBanc Capital Markets
Got you, and you mentioned in you [inaudible] you expect sort of a recovery in the back half, is that just sort of just based on history, or is the tire demand eventually coming back at one point, or is there something that gives you a little bit more confidence?
Patrick M. Provost
Well, I think we’d be disappointed with where the tire industry, you know, has been positioning against [inaudible] in the last few quarters. We look at the longer term trends in terms of tire demand against the economic activity, and we believe that currently we are below trend, and when I mean trend, I’m looking at 20 year type data, and at this stage, we believe that the underlying demand for tires seem to be, you know, well below the trend line which gives us hope that there will be a recovery later this year, and as I mentioned, in 2009 we saw very steep recovery as results of the return of the economic activity.
Ivan M. Marcuse – KeyBanc Capital Markets
Great, and when you move to the air with sort of an expression and pricing, and volumes being fairly weak, at least in the first half of the year – I mean, you should – is there anywhere in the business where you can offset this to improve margins, or do you expect some contractions in overall operating margins for the business through the year knowing what we know now?
Patrick M. Provost
So, this is specifically about the reinforcement in materials business?
Ivan M. Marcuse – KeyBanc Capital Markets
Yes.
Patrick M. Provost
While we – you know, we certainly are continuing to drive our value pricing strategy, and within that strategy, we have a product as well as a volume approach, so we will continue to be very active driving the differentiated parts into the market, and looking at ways to gain traction there, but of course, you know, the business is a scaled business where volumes are critical with regards to our profitability, and as I had mentioned, our utilization rates have been at least 75 to 80% levels which of course make it very difficult to gain or achieve they type of profitability we would expect.
Ivan M. Marcuse – KeyBanc Capital Markets
Got you, and then my last question, in terms of [inaudible], the detail is great, but if you’re looking at 15 cents of incretion this year, and then you look into ’14 and you still expect to get the 40 cents or so of incretion, what’s going to change between ’14 and ’13 since the rules aren’t going to come in until ’15 and you’re still going to still have sort of an over capacity issue, I assume, going into next year, so it gives you sort of the confidence you’re going to be able to more or less triple earnings by that point.
Patrick M. Provost
Right, well, there is a certain number of factors that I mentioned that the 15 cents of incretion in 2013 are partially impacted by some inventory reduction effects, and also we are going to be adding some cost to manage the integration, as well as the – as managing the drive for this two year transition to the regulatory environment. We do see some improvements coming from system sales as the industry is in need of injection systems to deal with mercury removal, and we have a business that actually deals with that, so we actually design and build mercury removal injection equipment, and we’re seeing a tremendous growth in terms of the number of projects that we are asked to develop and manage, and we believe this is an important part of that transition.
The other thing that we’re looking at is capturing some additional cost energy that we hadn’t identified when we spoke to you earlier, and then finally I would say that beyond the mercury removal which is about a third of the volume, we see some really good growth that seems to not be effected by the slow economy. So, all of these factors together give us, you know, confidence that the 40 to 50 cents incretion and 2014 is right in that space.
Ivan M. Marcuse – KeyBanc Capital Markets
What’s your example on – I guess just a follow on to that, so what’s an example of a synergy that you’re getting from [inaudible], and were they more than you though, and could you quantify that – so, is this more than – you know, is this an offset to I guess the hint that there is a lot of pressure in pricing on the competitor [inaudible], or do you think there’s going to be an add on?
Patrick M. Provost
I will let – Eddie’s been very much involved in the details with regards to the integration here and the synergy captures. Eddie, would you like to take that question?
Eduardo E. Cordeiro
Yes, so, Ivan, we’re looking to capture something in the order of 10 million in synergy, and we would see these in places like purchasing transactional capabilities – things that sort of popped up that we weren’t expecting – insurance costs have come down dramatically. We don’t need to buy a certain type of chemicals have been reduced significantly.
So it takes us a little while to implement the appropriate structures and that’s why we’re looking at being able to achieve those.
Ivan M. Marcuse – KeyBanc Capital Markets
Great. I’ll jump back in the queue.
Thanks.
Patrick M. Prevost
Thank you.
Operator
Thank you. And your next call comes from the line of David Begleiter.
Please go ahead.
David Begleiter – Deutsche Bank Securities, Inc.
Thank you. Patrick, just on, again, Norit.
The reduction in the U.S. coal-fired utilities market, can you quantify what that’s been over the last 12 months versus – and what are you new expectations on the market on an EPS accretion standpoint or some metric going forward?
Patrick M. Prevost
So, hi, David. So we, as you can see, we indicated that the reduction of the coal-fired utility has been the main driver for the 2% reduction in volume at quarter – year over year on a quarterly basis.
The air and gas purification part of that is approximately 10 to 15%. So there’s been a significant reduction that comes from the, you know, one, the fact that the coal-fired utilities are actually slowing down production in favor of the gas-fired power plants.
And secondly, which was more interesting, is the fact that total power consumption in the U.S. has actually come down somewhere around 2%.
So there’s a double effect that we’re currently seeing.
David Begleiter – Deutsche Bank Securities, Inc.
Fair enough. Just, in terms of Norit in Asia, I know you’ve hired a new management talent in Asia.
What’s your Chinese sales today and what’s the Chinese opportunity over the next, perhaps, three to five years at Norit?
Patrick M. Prevost
So I don’t have the Chinese numbers exactly, but we’re currently in Asia-Pacific at – in and around – or slightly less than 10% I believe, of the total Norit business and we believe that there’s significant opportunity to do more there. I mean, just in terms of the coal-fired utility, this is a market in China that is not being developed.
There’s approximately 85% of the power generated in China is based on coal and you know, some estimates in terms of mercury, mercury projections into the atmosphere – we talk about numbers that are ten times higher than the U.S. The U.S., currently, is estimated to emit about 60 tons a year of mercury in the air.
In China, people are talking about 600 tons. The Chinese government is very aware of the situation and we’ve been in contact with the – with Chinese delegations that are looking into this situation.
We have a good position in China where we’re well regarded and have a strong reputation we are engaging with the local authorities to see how we can help them solve this problem.
David Begleiter – Deutsche Bank Securities, Inc.
And just lastly, Patrick, on carbon black in China, how much are prices down in terms of profitability of your carbon black plant there? How much as it been impacted by from a margin perspective?
Patrick M. Prevost
This is an area we’re uncomfortable providing information because of the competitive nature of the data. So I’m sorry, I’m not going to be able to help you on that one.
David Begleiter – Deutsche Bank Securities, Inc.
Understood. Thank you very much.
Patrick M. Prevost.
Thank you.
Operator
Thank you. And your next question comes from the line of Laurence Alexander.
Laurence Alexander – Jefferies & Co.
Good afternoon.
Patrick Prevost
Good afternoon, Laurence.
Laurence Alexander – Jefferies & Co.
I guess first of all, on CEC, you know, what scenario would we see a significant uptick in the amount of royalties? I mean, is there anything that we should be looking for in the next three to five years where it will make a material difference?
Patrick Prevost
Well, I think that, you know, we’ve been working since 2008 with Michelin on developing the technology, but also on preparing Michelin to apply this technology in their manufacturing processes. We’re at very early stages right now.
The technology provides significant performance differentiation but of course, it also requires the building of tires that then need to be sold and I believe that creates, of course, some uncertainty with regard to the speed at which we will see the royalty steam develop. But we’re very confident that, you know, the technology is high performance and the royalties will, of course, the way the license agreement is structured, ramp up with Michelin production.
Laurence Alexander – Jefferies & Co.
Now, with performance materials, with the strength that the recovery that you’ve seen so far this year, do you think that Q2 is on track to at least match Q4 or can you somehow help us gage like how confident you are that this recovery is actually significant?
Patrick M. Prevost
Yeah, it’s a little early to be that certain. We’re only 1/3 of the quarter on our way, but let me tell you, the recovery matched the inventory reduction effect that we saw in December, which was very significant.
So we’re pleased with the fact that the thesis of destocking was confirmed and we’re seeing the business, in January, moving back to the type of volumes and financials that we expect.
Laurence Alexander – Jefferies & Co.
So maybe to come at it from another angle, so you reduce decretion on the purification solutions and the near-term pressure in reinforcment materials, is the recover and performance material, do you think, in a reasonable case, strong enough for you to at least be confident that you can have earnings be at least flat year over year for the full year or do you think earnings will actually end up being down?
Eduardo Cordeiro
You know, Laurence, I think at this point it’s going depend somewhat on how we see some of these markets come out of the new year. You know, we have – we’re certainly seeing some strength on the performance side.
On the reinforcement side, you know, one big question will be how does Asia-Pacific come out of the Chinese New Year, which is going to take place in February? And what happens in Europe, quite frankly, which, you know, you sort of hear mixed results these days.
I think those would be the key drivers which will determine where we end up at the end of the year.
Patrick M. Prevost
I think, as you heard, we’re very cautious about the second quarter in view of what we have seen in the last few months, but we’ve been disappointed by the overall environment and the ability for us to – well, the volumes that were given to us by our customers and it really looks like, you know, this could last a little longer. We do see some signs that the European economies are improving.
I mean, certainly in the U.S., there’s some optimism, but it’s a bit early for us to be showing more optimism.
Laurence Alexander – Jefferies & Co.
And then lastly, just very quickly, the new round of synergies over cost cutting that you’ve found, any cash outlays near term that we should be modeling on the cash flow statement?
Patrick M. Prevost
No, we did – as you remember, we had talked about the restructuring in the advanced technologies segment. That was last quarter.
With regard to the synergies on the purification solution side, there’s no, you know, there’s no cash outlays to achieve those.
Laurence Alexander – Jefferies & Co.
Thank you.
Patrick M. Prevost
Thank you.
Operator
Thank you. And your next question comes from the line of Christopher Butler.
Christopher W. Butler – Sidoti & Co. LLC
Hi, good afternoon, everyone.
Patrick M. Prevost
Good afternoon, Chris.
Christopher W. Butler – Sidoti & Co. LLC
You know, starting with Norit, you had mentioned that market share was a big part of the strategy now with some new contracts. Could you – has that changed from where you were in 2012 and how you approach customers?
Patrick M. Prevost
Well, has the market share changed or the strategy changed?
Christopher W. Butler – Sidoti & Co. LLC
The strategy towards, you know, holding onto market share versus what I assume to be price?
Patrick M. Prevost
I would say that the, you know, with the decline in the total volume available, we’ve seen a more aggressive competitive environment, which we will most likely continue to see through the course of this year. We have to make the decision to maintain our position in this market.
We’re still the leading player with regard to coal-fired utilities because of our technology lead and our early engagement in this market. And we have in and around 50% market share and believe that that still is where we are today.
We’re, of course, now planning for the ramp up in demand that will occur over the coming two years to meet the regulatory hurdle of 2015 and in that respect, we’re adding resources in the organization and we have a plan in place to manage the challenges both at the technical and commercial level. And I mentioned earlier that implementing and selling new systems is part of the work we’re doing within the next two years.
But we’re also having to engage very actively with the various utilities around the U.S. to help them develop their plans and help them prepare for the new regulatory environment that they will face.
And as we look at it today, there will not be enough capacity around in 2015 to meet the needs of the market even on a conservative basis. And that means that there will be new capacity needed, but this new capacity can only be built if we get a certain amount of commitments from the customers in the long run.
So this is the, you know, the work that we’re actively engaging in as we speak.
Christopher W. Butler – Sidoti & Co. LLC
As we look at the marketplace for Norit, others in the space are looking for ways of cutting costs without reducing capacity for the eventual regulation, yet you’re moving in the other direction. Should we look at that as Norit was probably a little bit too lean before you took over?
Patrick Prevost
Well, I would say that, you know, Norit was well managed, but if you think about Norit being owned by a private equity, the longer-term approach and the strategic engagement around creating value was certainly a different one compared to what we’re looking at and their exit strategy and timing was such that the – that there was certainly less worry about the 2015 hurdle. So I believe that, you know, part of that is correct.
Yes.
Eduardo Cordeiro
I guess, Chris, just a follow up on that to make sure – we’re looking at adding a little bit of cost in places where we think it’s strategically important to accelerate the growth opportunity. But if you look at that relative to the synergies we’re expecting to achieve by 2014, you know, they’re quite a bit lower than that.
So just a way for you to think about that.
Christopher W. Butler – Sidoti & Co. LLC
I see. You had also talked about strengthening regulations and if I remember last time regulations got strengthened, the compliance date got pushed out by five years.
So could you give me a sense on what you’re seeing as far as that’s concerned?
Patrick M. Prevost
No. We’re seeing, you know, a very strong commitment by the current administration to implement on April 1st, 2015 or April 15th, I’m not sure exactly the date.
There could be and they will be, perhaps for certain utilities, you know, up to a 12-month to implement. But all in all, I believe that it’s very much in early 2015.
Christopher W. Butler – Sidoti & Co. LLC
And just finally, last quarter you had higher fee stock inventories on the reinforcement to business. Any lingering headwinds on that that we saw here in the first quarter?
Eduardo Cordeiro
In the first quarter we – we eliminated most of that, but there was some that was still evident in the first quarter. But the higher margins that we reflected were in part due to the fact that we did not have those – as many of those headwinds in the first quarter as we did in the fourth quarter.
Christopher W. Butler – Sidoti & Co. LLC
Now, it was 6 million in the fourth quarter? Was it a million, or 2 million in the first?
Eduardo Cordeiro
Yeah, it was in that sort of half of the fourth quarter range.
Christopher W. Butler – Sidoti & Co. LLC
Okay. I appreciate your time.
Operator
Thank you. And your next question comes from the line of Jay Harris.
Jay Harris
Good afternoon.
Patrick M. Prevost
Good afternoon, Jay.
Jay Harris
As you move to achieve your – we’ll call it a $5 earning power over the next whatever period it takes to get there, what kind of organic top-line growth rate should we be thinking of for the company as a whole.
Patrick M. Prevost
Okay, Jay, so the – I’m trying to think, perhaps the best way to anchor this to think about our last investor day where we talked about the move from $3 per share, which was achieved in 2011, to $4.50 per share, which was the target of the legacy Cabot portfolio. So this is the growth that we had projected.
The $5 or $4.90 to $5 that we are currently targeting is a result of the addition of Norit, which is still, today, planned to be $0.40 to $0.50 accretive in 2014. So looking at that, you are looking at 10% or so of earnings growth per year.
Jay Harris
I’m talking about revenues.
Eduardo Cordeiro
So Jay, right or wrong, we sort of conditioned ourselves not to focus on top-line percentage growth because it moves significantly with raw material costs that get passed through. So I think, you know the way we’ve tried to articulate it is that when we initially set the goal of $4.50 from $3, pretty much all of that was organic.
And if you remember, some of that, you know, about 30% was coming from margin, about 40% from capacity and another 30% from new products. The other $0.50 that gets us from $4.50 to $5 is really the Norit acquisition.
So that would be inorganic. So that jump is basically 3/4s organic, ¼ inorganic.
I would have to take a step back and sort of think about how to normalize for raw materials cost and what that would translate into in terms of top-line revenue growth.
Jay Harris
I’d like to encourage you to do that because I think the earnings growth prospects will get you a higher multiple with revenue growth rates, higher revenue growth rates than with lower revenue growth rates adjusted for pricing, if you will.
Eduardo Cordeiro
So we’ll take a look at that, Jay. It gets complicated for folks because, you know, we have to make adjustments for raw materials, but we’ll take a look at that.
Jay Harris
Coming back to, if you don’t mine my using old language, carbon black, are all the – it was obvious that there were customer inventory adjustments around the world from your comments in first quarter. Are there any yet to be accomplished that you’re aware of?
Eduardo Cordeiro
So the question is, where do we feel we are in terms of inventory in the chain?
Jay Harris
Yes.
Eduardo Cordeiro
So I think certainly from the performance material side, the carbon black side, the special black side so to speak, we feel as though we’ve gotten to very low levels in the chain and we’re now seeing some restocking taking place. And we think on the reinforcment materials, the rubber black side, it’s also at a very reasonable level.
So we wouldn’t expect to see much destocking there given where we are right now.
Jay Harris
And you indicated that you wanted to do some destocking. What are order of magnitude?
Eduardo Cordeiro
That was really more just on the purification solutions.
Jay Harris
Okay, okay.
Eduardo Cordeiro
So we feel as though we can run the supply chain a little better than what we’ve seen going in. That will generate some cash for us, but will be a P&L hit, of course and that’s in part why we took down the accretion for this year.
But we’ll be through that by the end of this year.
Jay Harris
And what order of magnitude are we – you had $587 million of inventories at the end of December, are we talking 50 million, are we talking 90 million?
Eduardo Cordeiro
Well, generally, I believe that the working capital is a bit too high right now. We tend to see a bit of a spike in the December quarter because we pay out some year-end accruals, which took place earlier; I think in order of 100 million in terms of the overall company’s working capital.
We can lighten up depending on feedstock [inaudible], of course, but we would like to see about a $100 million improvement there and that includes, you know, all businesses, of course.
Jay Harris
Coming to drilling fluids, that was a rather large drop in activity levels going from the September to the December quarter. Something different happened this year than in prior years.
Can we get a little more detail?
Eduardo Cordeiro
Yeah, it’s not really a year or a seasonal thing, it is unfortunately because of the way we have to record the revenues. We had sort of low activity levels and also no real events that created a recording of revenues.
And so we believe we’ll see some improvement here in the next six months. As I sit here today, I can’t give you an exact forecast because of just the nature of the business, even for the second quarter.
But we do expect a substantial improvement in the second quarter.
Jay Harris
Are there activities on the horizon that get you back up to former peak levels or above?
Eduardo Cordeiro
I would say so, yes.
Jay Harris
Okay.
Eduardo Cordeiro
And through an 18-through-24 month period.
Patrick M. Prevost
Right, and the, you know, as you can imagine, Jay, we’re very close to a lot of the customers and the service companies and the oil companies that use our product and we have visibility on the projects that would use cesium formate. And that visibility is fairly extended in terms of several years ahead.
I think the biggest challenge is really the project nature and sometimes it gets accelerated, sometimes it gets delayed and we suffer from the lack of clarity and we can swing from one quarter to the next very quickly and that affects the way we can record the sales.
Jay Harris
It was rather traumatic.
Patrick M. Prevost
Yes, absolutely.
Jay Harris
Are you opening up any new geographic areas for cesium formate?
Patrick M. Prevost
So as I mentioned earlier, we have been making headways in Asia and we’re very pleased because we’ve seen adoption of the use of cesium formate in Asia and India and in Malaysia. And I believe in [inaudible].
We’re also qualified and have some very interesting prospect in [inaudible]. But all in all, what I see is the continued recognition of the performance of this material over our alternatives and although you know, the price tag is often seen as a hinderance for more growth, we still see the performance in the end prevailing and we’re very optimistic of the – about the continued growth of this business.
Jay Harri
And then final question I have is on the new products and a few metal oxides. Are these just the same materials with new applications?
Patrick M. Prevost
No, we’ve launched some new products that are extensions of our existing portfolio product, but that provide higher performance in adhesives, in sealants, in applications that the wafer polishing applications. So in these very important areas we see strong leads and we’re – we’ve been ramping up our R&D and applications development efforts and as we see the need for us to differentiate, as our customers become more sophisticated with regard to their needs.
And I’m really pleased with the – how things are developing there. And we’re, you know, we’re also seeing in general a positive development in the housing sector.
This is an area, you know, except of course for electronics, but for example, silicone sealants are very much driven by housing and U.S. housing and even housing in Europe is improving and we’re seeing that starting to affect our business positively.
Jay Harris
Thank you, gentlemen.
Eduardo Cordeiro
Thank you, Jay.
Operator
Thank you. I would now like to turn the call over to Patrick Prevost for closing remarks.
Patrick Prevost
So ladies and gentlemen, thank you very much for joining us today. I am looking forward to speaking to you again in about three months.
Again, thanks and good bye.
Operator
Thank you for joining today’s conference. This concludes the presentation and you may now disconnect.
Good day.