Greetings, and welcome to the Orion SA Second Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [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. Thank you, ma'am, you may begin.

Thank you, Kyle. Good morning, everyone. And welcome to Orion's conference call to discuss our second quarter 2023 financial results. I'm Wendy Wilson, Head of Investor Relations. With we say, are Corning Painter, Chief Executive Officer and Jeff Glajch, Chief Financial Officer. We issued our press release after the market closed yesterday and we also 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 the 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, and our actual results may differ from those described during our call. In addition, all forward-looking statements are made as of today, August 10. The company is not obligated to update any forward-looking statements based on new circumstances are revised expectation. All 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. Good morning, everyone and welcome to our earnings conference call. As you can see on Slide 3, we had another excellent quarter second only to the first quarter naturally making for record first half performance. Our results reflect the hard work of the Orion team to fundamentally transform the company, providing the industry-leading products, customers' demand and returns on investment that investors deserve. We've been aided in is by a restructuring in the broader marketplace that has been building for years in our key markets, has now passed the tipping point and still continues to build. We continue to be one of the few specialty chemical companies on track for a stronger 2023 compared to 2022. And we expect record profitability this year. We delivered second quarter adjusted EBITDA of approximately $87 million, a 5% increase year on year, and adjusted diluted earnings per share of $0.53. This resulted in record adjusted EBITDA of approximately $188 million for the first half a 13% increase year on year and record adjusted diluted earnings per share of $1.27. We also delivered strong second quarter operating cash flow, reduced our debt level, while also completing our $50 million share buyback and starting on the new buyback. We expect to generate more than $200 million of discretionary cash flow this year, reflecting a conversion rate of over 60%. This is a huge step up for us which we expect to maintain. Jeff will discuss this further. As you have seen, we recently published our 2022 Sustainability Report. I highly recommend that you take the time to read it sustainability is central to our strategy. In specialty, this manifests in conductive additives and in rubber as a circular economy. A concrete example of this is our acetylene-base conductive carbon. They are ultra…

Thank you, Corning. On Slide 5, you can see the continued path of growing profitability, even with the headwinds in our end markets. In 2023 we expect at the midpoint to grow EBIT to 7% versus the full year 2022. And while not shown here, EPS is expected to grow at 9%. Our portfolio is a combination of the rubber business which is benefiting from price increases that have more than offset the near term volume challenges and our specialty business which is kept stable pricing with its high value add products. Specialty too is facing near term volume headwinds. But the 50% plus growth in rubber, EBITDA in Q2 and in the first half of 2023, has allowed us to deliver respectable earnings growth. Below, you can see our continued ROCE progress over the past few years during a time we made substantial air emission control investments. The ROCE level we achieved are significantly in excess of our weighted average cost of capital. ROCE stands at 17%. This key metric keeps us aligned with our shareholders as stewards of their capital and focusing on the long-term sustainability of the company. Now some more details. On Slide 6, our consolidated results for the second quarter. The contractual price improvements in rubber outweigh the lower volume in both businesses as well as lower cogeneration revenue. The year-over-year adjusted EBITDA increase of 5% in the second quarter, and the 13% of the first six months of 2023 are a direct result of better pricing in rubber. You may note that the adjusted EBITDA is down in the second quarter despite the increase in EBITDA -- adjusted EPS I'm sorry. This is a combination of the higher tax rate in the quarter, and a couple of adjustments items to net income, which went…

Thanks, Jeff. Turning to Slide 15. As we both said earlier, we continue to believe we will record another record year. We also believe that we're in a strong position going into 2024 with about 60% of our Americas and EMEA robber demand already essentially committed. For this year, we expect any customer purchase deferral and destocking to continue into Q3 and Q4. We also expect the lower power prices in Europe to continue to prevail. Taking that into consideration, we are upgrading our adjust -- updating, excuse me, our adjusted EBITDA guidance to the $320 million to $350 million range, which is up over 7% at the midpoint. Our adjusted EPS guidance range of $2 to $2.25 per share, and up 9% year-over-year at the midpoint. In closing, I would remind you that first, our specialty businesses is doing well. Naturally, volumes are down when manufacturing activity is down. However, our unit margin reflecting the strength of our business is holding at high levels. Meanwhile, we're driving our future growth by progressing our conductive additive plant in La Porte and advancing customer qualifications across many markets. Second, we believe the step up in our rubber pricing is necessary and at a sustainable level from which we will grow. Third, the current disconnect between miles driven gasoline consumption and replacement tires is not sustainable. Those tires will need to be replaced. Also, the OEM market which drives our higher margins, specialty and MRG businesses has begun its recovery. Fourth, with higher profitability and the U.S. air emissions spending nearly behind us our cash flow conversion has improved dramatically. I continue to see a great future for Orion as a company and as an investment. The steps we have taken and the strategy we have embarked upon provide a great foundation for sustained profitable growth, free cash flow and exceptional returns for our shareholders. Thank you. Kyle, please open the line for questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Chris Kapsch with Loop Capital Markets LLC. Please go ahead.

Hey, thanks. Good morning. So thank you for the details around the characterizing the ongoing tire contract negotiations for next year. Could you remind us like what percentage of your existing contracts already had multiyear agreements in place where there was, already an increment in pricing baked in for next year or beyond? And curious about the agreements that are being resolved now. How does magnitude of pricing that you alluded to compared to those that have already been baked in to the multiyear deals? And if there's any way to characterize this by geography, that'd be helpful too?

Hi, Chris. So first of all, thanks for your question. Appreciate it. So we had about 50% of our volume under contract going into it. As you said, we had a step up in those contracts going from '23 to '24. I expect that we will do better than that, with the new contracts that we signed this year. It's early days, but that's my expectation. And I'm okay with that because I think it's a better allocation of risk getting commitments between the companies and we're prepared to do that sort of thing. I think that's a good development overall, for the industry. I'd say in general, there's more interest for people to get the contract quickly in Europe right now, and -- versus North America or South America just because of the upset there with the Russian capacity, which was probably about 35% of that market. Some customers, as we estimated as much as half of their carbon black was coming from Russia. So there's certainly some people who are quite interested in that. Did I miss anything there, Chris?

No, that covers it. That's helpful. And then the follow up would be, no, I like the way you characterized the current destocking presumably represents deferred or latent demand, incremental demand for next year. So assuming that this de-stocking runs its course, let's just say by calendar year, and then there's normalization and demand trends next year. Is there any way to characterize what you think that the industry capacity utilization rates would be by region in sort of the core rubber black and specialty area? Thank you.

Sure. So just to clarify, I think, it's not one day whenever a customer decides, okay, I'm going to stop deferring. I think we'll see that turning in the fourth quarter. I don't think we as the company will see the impact on that until January, just because in the fourth quarter, you've got holiday shutdowns and that kind of things. I think it's that kind of a timeframe been a relatively long deferral. What I think that means for us, then going forward, is rubber capacity in Europe will be at very high levels. And that will be basically where people can operate it at. So I would say high-80s, low-90s. I think North America will also be very high levels of industry utilization again, just because of supply demand. We get back to a more normal run-rate in demand. I think, capacity in both areas will be tight. We will have our EPA work behind us. At least one major competitor will not right, so when they go through it that'll probably have an impact in demand or capacity for North America next year.

Helpful, thank you.

Our next question comes from Jon Tanwanteng with CJS Securities. Please go ahead.

Hi, thanks for taking my question. I was wondering if you could give us a little bit more color on the inventories that your customers, compared to where they would normally be in this kind of demand environment and how long they can actually keep drawing down before they reach a critical levels or levels have put their business at risk. Have your customers actually told you that they're specifically drawing down? Or is that just more research on your end based on what you're seeing in the market? Just help us get more clarity on what's giving you the confidence that things will come back and kind of when they will?

Sure. So two things there. Number one, is of course, cutting across many different customers in specialty many, many, in rubber, let's say many. Those customers don't always express tremendous competence in exactly what is in all the downstream channel. So I know everybody's interested in this question of de-stocking. I'll just tell you, I think end customer demand and the deferring there, which you can see in that gasoline and miles driven versus replacement tires, I really think that's the best data we have. So now more anecdotally, when you talk to these guys, they talked about, yes, we're at a very low inventory level. If end customer demand dropped lower, will then that might be a little bit more inventory than they think they need, they might be able to draw that down. If it steps up a little bit, right, they would have to buy a little bit more. I think they're low levels, I will never tell you, it can't get worse. So they couldn't destock more. But our view is and when we talk to these guys, they all express, they unbalanced express that they're at low inventory levels, but very reluctant to make a step up in inventory. The one thing we may see in this month is with the rise of oil prices, we may see some people buying in front of that in specialty. Okay, that'll help August or September, I don't see those very significant.

Okay. Got it. And then--

Maybe just one other thing, you have a few guys who have talked about, a little bit of uncomfort that they're like below their safety stock level. But again, that's some, you have to really look across the balance and the whole industry.

Okay, understood. As your customers get down to these critical inventory levels, assuming demand stays roughly where it is. I mean, how much leverage does that create on pricing for you, as you enter the New Year? I know tire contracts are generally negotiated for ahead of time, but in the rest of your business, when that give you also some a lot better leverage as you enter the New Year, especially the capacity remains limited and you guys start to restock.

What Jon. the way this game works is, the buyers right now are saying, demands you need to load you need to give me a good price. And we're saying, yeah, no, no, no, no, we're not negotiating for 2023, we're negotiating for 2024. That's an obvious thing in the annual cycle for rubber. But it plays out in specialty as well. But the key point here is in specialty, we're selling value. We're selling a solution. So we're not looking to take advantage of the market conditions nor be a victim, right. We're looking to keep a fair price in our specialty, and move it up where we need to and get our new products qualified and basically be agnostic to the current market conditions. But yeah, I mean, I think to an intelligent buyer, they can see what's going to happen next year.

Okay, great. And then just one more thing, can you just break out the impact of cogeneration? Kind of what has been your expectation? And what has been the change there, I guess, in the outlook that specifically from that piece of the business?

Sure, I can let Jeff go more. But just to say when we gave our last guidance right at the end of Q1, we were really looking at what power rates were at that time. And we expected them to just stay where they are, a thought that they might actually pick up a bit this summer in Europe, which has not happened. And I think it was in my part of the script last quarter, when I said that for every move of about 20% would be about $10 million. And it's moved about 50% down. So that's how you get to an annual run-rate of 25 that Jeff mentioned. But, Jeff, anything you want to add to that?

Sure. Jon, yeah to Corning's points, the 50% reduction in power prices would get you, getting somewhere in the $25 million range from a profitability standpoint. If you look right now in the key markets. I think if you were looking at Germany, it's down about 50%, perhaps a year-over-year. If you look in Italy, it's maybe closer to 40. There's not been a step up in the summertime, even though it's very hot there. There's not been a step up in summertime power costs. So we're, as the year goes on, we're expecting this lower level to remain which is lower than what our expectation had been three or four months ago. So we had a little bit impact in the first quarter, a little bit more than the second quarter and expect the bigger impact and the third and fourth quarter if these levels remain where they're at.

And just to give you my note. Like this is a net positive for everybody. It's going to mean the Europeans fuel [ph] economy is stronger. It's ultimately going to help consumer demand in Europe. One of the things to understand is that we did hedge last year, congratulations to our energy team. It was very good timing. Those hedges will extend, expire at the end of this calendar year. So that's going to give us a headwind next year of about $10 million.

Great, thanks, guys. I'll jump back in queue. Thank you.

Our next question comes from John Roberts with Credit Suisse. Please go ahead.

Thank you. Slide 10 has the year-over-year bridge for the speciality chemical EBITDA. If you're going to build that slide on a sequential quarterly basis, what would it look like? The volumes were actually relatively flat sequentially.

Yeah, so I would have to take a quick look at that. I think that our price mix has not shifted dramatically time on quarter-on-quarter volume. Jeff, how do we look quarter on quarter?

I think volume might be down a little bit versus --

It stayed on the right-hand column to give the quarter-over-quarter [multiple speakers]

I'm sorry, I'm looking at Slide 9. Different counter slides about it. So I'm sorry, your question then with comparing these two, what in particular, would you want?

Yeah, sequential decline? Because volume was stable. Sounds like price was mixed significantly negative sequentially.

Yeah, mix was

Yeah, John. I thought you were asking about looking forward to Q2 to Q3. Q1 to Q2, yeah, mix was down as well. We talked about the cogeneration piece that hits a specialty pretty significantly. And with a lower volume, there was a little bit more fixed cost absorptions. So you kind of throw it all in a basket. And you can see really, it's a gross profit line.

Plus, we shared last time that $101 million of EBITDA benefited for some onetime and timing effects. And a lot of that was in specialty that's partially have the GP per ton was so high in specialty in Q1. So just the absence of those things, we're going to take the profit quarter on quarter down a little bit as well.

Yeah, that alone is probably a third of the reduction.

Okay. And then how are your China operations doing?

So we were volume positive, there, where a startup of a new plant. I think, China is a weak market now. That is for sure. I think one thing to keep in mind for us is that on rubber, we are like 100 KT, a 4,000-5,000 market volume market. So for us to find ways to place our product was maybe a little bit easier than other folks. We're very busy with the startup and everything associated by that. But otherwise, tough market, but we're fighting it out.

Our next question comes from Josh Spector with UBS. Please go ahead.

Yeah. Hi, thanks for taking my question. First, I want to make sure I understand the cadence through the rest of the year correctly, and how you're thinking about the moving pieces. I guess, from what I've heard so far, it seems like maybe there's a 5 million sequential step down because of the co-gen energy dynamic. Seems like demand sounds stable-ish at these lower levels. So maybe you're in the low-80s range for 3Q, 4Q typically is 10% lower or so? I mean, that gets me roughly to the high end-ish of your guidance. I guess what else would be the moving parts in their volume or otherwise to consider?

So, I'll just make a couple of general comments. And I'll let Jeff. So Jeff try and go into specifics for you around it. But I would also just say, we and a competitor, both mid-quarter made some announcements about how we saw volume. It is a fairly dynamic time. I think the industry, meaning the tire guys were surprised, for example, about the trucking volumes. And just as we had some positive things happen in Q1 these things can balance themselves out over time. But Jeff?

Sure. Josh, I think your thought process on Q3 is probably not too far off. I think about Q4, typically you see some shutdowns by our customers. And as Corning mentioned earlier, the thought is perhaps so shutdowns maybe a little longer than normal. I think that's probably a meaningful impact. If I think about, if you look at last year's Q4, one way to look at our guidance, if you look at a midpoint of our guidance, it would suggest that Q3 and Q4 are in-line with what Q3 and Q4 looked like last year. Obviously, we get the benefit of rubber pricing but as you mentioned, the impact of the cogeneration, perhaps we've got a view on volume. We typically do see a drop off in Q4. And our thought process is with the dynamics going out of the market and our customers staying in lower inventory levels, that we could see a similar kind of drop off in Q4 of 2023 than perhaps we saw in Q4 2022.

Okay, that makes sense. And just maybe a little bit near term and long-term, I guess, your competitor talked about some more -- some pressure within some of the conductive carbon market pricing and demand. I'm curious if you could describe what you're seeing in your unsettling black demand and pricing at the moment. And also notice you trimmed some of your growth CapEx? I don't know if you're delaying anything there, but just timing of some of those investments. Just curious on the driver there. Thanks.

Yeah, hi. No, the change in our capital is more around execution and looking at certain projects and where we are on the timing for them. We continue to advance the acetylene project. We also would agree, there's China is a more challenging market, there is some differentiation of different materials used in different kinds of batteries, and so forth. What I'd add to that is, we also see that as an opportunity. And that for the LSP, we're also looking at some other products that are better price for that market and for their needs and the price points that they work out at. So given our overall size in this market, we see that as basically an opportunity for us, and one that gives us the ability to have multiple tiers of offerings going forward.

Okay, thank you.

Our next question comes from Laurence Alexander with Jefferies. Please go ahead.

Hi, this is Dan [Indiscernible] on for Lawrence. You mentioned that the rubber black supply demand tightness, I was wondering if you would consider adding either brownfield or Greenfield capacity and if not, what would have to change to kind of make that viable.

Sure. When you think about making an investment, you have to think about return of capital, which means you have to think about what's the right hurdle rate. And that means you have to think about what's the business model. And the current business model, or most customers do a short term contract. And by that, I mean one to three years. And all right, it's a little bit longer now than it used to be, but still very few more than one-three years. I think that puts you in a certain risk position around adding capacity. So we would really be looking for more of a longer term mutual commitment between the two parties. They would just give us more surety. And with that a surety, of course, we'd be willing to accept a lower hurdle rate. And personally, I think that is the way forward for this industry. And we'll see if we can move in that direction.

So I think we could describe it as something more akin to what we've seen industrial gases where there's a, I don't know, like a 10-year commitment and kind of co-building that is that we're probably thinking about?

Yeah, yeah. So I come from the industrial gas industry. I think there's two business models there, where there's dedicated capacity, those tend to have a 10-year agreement. There's also more of a merchant approach, which is more like five years, there's a little more flexibility. I think something in those areas is what could make sense to add capacity. That's our view of it.

Okay. And there's one more question. I think you mentioned adding new capacity in carbon additives in Europe. I was wondering if I don't know just the fluctuations ticking in energy causes, maybe having to rethink that, that building that region would be better, or maybe it's better to export into the region.

So let's be clear, we said that in the next three to five years, we see ourselves adding capacity in North America and in Europe. I think those will be growing markets. There's already a pretty large market in China. I think that we're going to see Giga fabs of batteries become more democratic, so to speak, and spread out geographically. And there's all these things about geopolitical concerns about trade and everything else. So we think there's going to be demand in each space. Based on that we will be interested in being there. But remind you, we're typically using a byproduct for not making our carbon black, I'm sorry, our assembling conductive material. So that's something that we would look to see how that balance out. But to be clear, if there isn't a good return on investment, we will not do that.

Thank you very much.

Our next question comes from Jeff Zekauskas with JPMorgan. Please go ahead.

Good morning. Jeff. Are you there? Maybe on mute?

Sorry. Can you hear me now?

Yeah. Good morning, Jeff.

Sorry about that. Yep. Good morning. In the rubber black area, you said that 60% of your contracts for next year were in good shape or signed. Is that all Europe or is that large number really reflecting the European market?

So let's just let's be clear, that is EMEA and the Americas combined?

Right. But if you strip it out, and like how much is in Americas and how much is in EMEA. Because they're very different markets? No?

I think for us, though, the, the percent contract is going to be similar, maybe it's a little bit higher in EMEA right now, just because people are going a little more quickly on that. But when we did last year, we ended last year with about half of our volume committed that's that was the ratio we chose to take. So that was pretty well split between Americas and EMEA.

So, in listening to what all the different companies that make carbon black, say, some companies point to a more contentious price negotiation. Are your carbon black prices simply lower in rubber black than some of your competitors, historically? And so you have more room to raise your prices. Is that a fair characterization?

So I don't know exactly what my competitors' prices are. The only feedback we get on that is from our customers, who are of course, very likely to lay out the scenario, you just said, Jeff. So I have no idea what their pricing is, what their pricing policy is, or anything else. I'd say the situation is a little bit of like, let's imagine there's an airline route. And there's only let's imagine, I don't know. There's 550 people who want seats, and but across the various airlines, there's only 500 seats. That's kind of how Europe is, it's kind of how North America is. So if someone's going to be discount offering, free lakers out there selling seats at a real discount, it doesn't matter. Because right, you can fill up his airplane, you can't like lease a new plan. It's not like the airline business, our business. And then what's left is left, it's just a fact. I think it's also important to know like, I don't think our prices or the industry prices are that high. People are like getting to return on capital pricing. This is where pricing needs to be. This is why that plant closed in North America, in my opinion. This is why this company closed in, but as in 2016. When I joined this company in 2018, and I did my first round out there with customers. I got, people giving me the very harsh words, that Orion had closed this plant in France two years ago. But why? It's because the pricing was too low, and people were buying from Russia, so we're just kind of like getting back to a balanced place in my view. I don't think it is extraordinarily high or anything else. Yeah, it's a change. But that's the change you need if you want to have reliable supply and plants to get invested and maintain. I think what's happening is a reset to normality.

I guess finally, can you talk about the trends in specialty pricing? And where they're going, are they moving lower, are they moving higher? And what the future of those returns is?

So we work hard for our end markets to have a value proposition in those places. And yet prices can move up and down with different impact energy amongst them. But we're not looking to fundamentally say, what we get in coatings isn't a high enough return for us. I think what our view is that our position is, we're looking at this time when demand is soft not to chase the volume by lowering price. So then when the market turns and the volume comes back, like your business is damaged is not as good as it once was. Our view is we're providing value, we're providing a solution to our customers, that we should maintain the, I must say, unit price in that space, you are still going to see fluctuation in our overall GDP per ton on mix on things like power, but our view is the value of this product is not diminished, just because demand is a little slower right now.

Okay, great. Thank you so much.

Next question is a follow up from Jon Tanwanteng with CJS securities. Please go ahead.

Hi, I was just wondering if you could give a little bit more color on your plans for the buyback. I think you said you're going to be a little bit more measured and less aggressive, compared to the $50 million that you've already spent. But if share prices go lower, I mean, how does that rank compared to the other uses of cash that you're considering with debt pay down your investments and future CapEx as well?

Hey, Jon. This is Jeff. If you think about our buyback, our first $50 million buyback, we bought back shares at approximately $10 million per month to get that $50 million by mid-May. And then since mid-May, we took that pace down a little bit. But to your point, we are looking at this opportunistically, I think it is probably fair to assume that we'd be a little more aggressive if prices were lower and a little less aggressive if prices were higher. So it's not a static model. Our thought process is very dynamic there and we will be more aggressive if prices are perhaps a little bit lower.

Okay, thank you.

There are no further questions at this time. I'd like to turn the call back over to Corning Painter for closing comments.

Okay. I'd like to thank our analysts for your excellent questions and the time today. Thank you very much. This is an exciting time for our company and for the industry. And we really appreciate our investors continued support. We look forward to seeing you very soon. We're going to be escaping the heat of Houston by coming up for two conferences in New York in September. And we welcome other opportunities to meet you. We're out in the road this fall. Thanks again. Have a good day.

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