Earnings Call Transcript - OEC Q2 2025

Operator, Operator

Ladies and gentlemen, greetings, and welcome to the Orion S.A. Second Quarter 2025 Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Chris Kapsch, Vice President of Investor Relations. Please go ahead.

Christopher John Kapsch, Vice President of Investor Relations

Thank you, Ryan. Good morning, everyone. This is Chris Kapsch, VP of Investor Relations at Orion, and welcome to our conference call to discuss second quarter 2025 results. Joining our call today once again are Corning Painter, Orion's Chief Executive Officer; and Jeff Glajch, our Chief Financial Officer. We issued second quarter results after the market closed yesterday, and we have posted a slide presentation to the Investor Relations portion of our website. We will be referencing this deck during the call. Before we begin, we are again obligated 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 Securities and Exchange Commission, and our actual results may differ from those described during the call. In addition, all forward-looking statements are made as of today, August 7, 2025. Orion is not obligated to update any forward-looking statements based on new circumstances or revised expectations. All non-GAAP financial measures discussed during this call are reconciled to the most directly comparable GAAP measures in the tables attached to our press release and the quarterly earnings deck. All non-GAAP financial measures presented in these materials should not be considered as alternatives to financial measures required by GAAP. And with that, I will turn the call over to Corning Painter.

Corning F. Painter, Chief Executive Officer

Good morning. Thank you, Chris, and thanks to everyone for joining our conference call. Before we dive into industry trends and Q2 results, I want to take a moment to acknowledge our Chief Financial Officer, Jeff Glajch, who will be retiring in the fourth quarter after nearly four years with Orion. His leadership and guidance will be greatly missed. We have begun a formal search for his replacement, and we appreciate Jeff's commitment to ensuring a smooth transition through the end of the year. Moving on to our Q2 results, we generated $69 million in adjusted EBITDA, which aligned with our expectations, despite encountering more significant demand challenges during the quarter. Overall, volumes increased by 3% year-over-year, but saw a decline of over 4.5% from the previous quarter. Improved manufacturing performance at our plants played a crucial role in our higher sequential earnings. As we mentioned last quarter, the unplanned downtime we experienced in Q1 was unusual, and our initiatives to enhance plant performance are now starting to yield results. In terms of demand challenges, we faced issues in both segments during Q2. For our rubber business, a surge of tire imports into the U.S. ahead of the early May automotive tariff deadline has been affecting local tire manufacturing rates and, consequently, our demand. In the Specialty segment, a combination of uncertain tariff situations, potential destocking in polymer end markets, and broader economic difficulties has contributed to a weaker demand environment, and Orion has felt this impact. Despite these challenges, some of our more profitable Specialty products have shown resilience, and we are making progress in getting new customers on board for our higher-growth conductive grades, including lithium-ion batteries and energy storage systems. The strong trajectory for our conductives product line, with a healthy double-digit CAGR, positions the Specialty segment well for long-term earnings recovery. In the near term, Specialty demand trends have been inconsistent. However, the recent trend of customers placing orders just in time suggests that inventories might be quite low throughout the specialty supply chain. Tariffs continue to be a relevant topic. We believe that the automotive tariff rates, which include replacement tires, will help stabilize tire imports into the U.S., reducing pressure on top-tier local tire manufacturers—our customers. We anticipate that this will lead to improved demand in our rubber segment starting late this year or early next year. Recently, focus has shifted to India, where even a 15% to 25% tariff could significantly impact the economics of carbon black imports into the U.S. Currently, Indian imports account for about 4% of North American market demand. With 2026 negotiations commencing earlier than expected, it seems that customers are eager to negotiate due to recent high tire imports and disappointing carbon black consumption. Additionally, as the U.S. Section 232 tariffs and reciprocal tariffs on India evolve, the overall situation improves for our operations. In Europe, a Chinese tire dumping investigation is ongoing, raising questions about whether the Europeans will maintain open policies toward their automotive sector. The effects of these developments have yet to manifest in business trends. Furthermore, there are potential risks for tire makers regarding carbon black and related imports from Canada or Mexico as USMCA renegotiations approach in mid-2026, with updates expected from the U.S. administration as soon as this October. We want investors to know that we are actively working on our self-help initiatives, focusing on productivity and cost reduction. We have altered our capital allocation priorities, favoring debt reduction over share buybacks in the near term. On Slide 4, we present recent tire industry data and our current outlook on tariffs' potential effects. Despite ongoing uncertainties, the originally proposed automotive tariffs have remained stable at 25%. The early May deadline has passed, which we believe contributed to the rise in imports. Historically, tire imports have represented around 50% of industry sales, but in the past year and a half, this has increased to over 60%. The industry is shifting toward lower-value tires, particularly Tier 3 and Tier 4 brands, due to consumer reactions to inflation. However, we expect the strong offerings from leading tire manufacturers and trade policy shifts will reverse this trend, as evidenced by the surge in tire imports at the time tariffs were announced. We predict that tire imports will decrease in June, as companies aim to finalize annual negotiations before new market data is available. Channel inventories for lower-tier offerings are likely high, but we anticipate they will be reduced in the latter half of 2025, leading to a recovery in production rates. To address concerns about whether increased import levels are structural, we’ve added Slide 5 to illustrate that major tire customers have committed between $7 billion and $8 billion to projects in North America to enhance or expand tire production capacity, scheduled to ramp up over the next four years. This is expected to contribute to a 3% to 3.5% CAGR in North America through the end of the decade, despite some announced closures. These investments signal the reshoring and deglobalization trends occurring, and they largely predate the new tariff landscape. On the carbon black front, we do not expect significant new capacity expansion in North America in the near term, given the lack of new projects. Similar trends of tire production reshoring are also evident in Europe, although there have been more factory closures in that region. On Slide 6, we discuss our recently announced production rationalization and other self-help initiatives aimed at strengthening our performance amid a prolonged business cycle downturn. Our decision to close three to five production lines, which accounts for less than 5% of our global capacity, is part of a broader portfolio optimization effort targeting lower-margin business. This choice was informed by a thorough analysis of cash flow performance at the level of production lines, product grades, and customer projects. Looking forward, having fewer reactors will allow us to optimize our maintenance capital and make more strategic choices regarding maintenance spending. We need to ensure that our assets are not sidelined when customers choose to source from unreliable supply chains. We are not merely waiting for demand to recover; we are actively pursuing initiatives to cut costs, as mentioned last quarter. Improving free cash flow remains our top priority, and we have made good progress, extracting $27 million from working capital in Q2 primarily through inventory management. We expect to see a reversal in the increase in receivables from Q1 by Q4. These working capital actions, combined with lower capital expenditures, support our ability to reaffirm our free cash flow targets. Jeff will provide more detail on these results shortly.

Jeffrey F. Glajch, Chief Financial Officer

Thanks, Corning. Before I start, I do want to thank Corning for his kind words earlier. As we announced last week, I have decided to retire in a couple of months but I intend to not only support Orion's search for a new CFO, but then to continue with the transition through at least year-end and perhaps even into early 2026. I've enjoyed my 3.5 years at Orion. I decided to retire for personal reasons and have only true respect for our Orion team. Finally, my opinion is with the tariff headwinds that Corning mentioned earlier, we could be on the precipice of a ramp-up in volume as we look at 2026. Now on to our Q2 results. On Slide 7, you'll see our business exhibited resilience in Q2, with volumes improving 3% year-over-year. We saw growth in our rubber business, but a decrease in Specialty due to hesitancy across our customer base, particularly related to automotive OEMs and the polymer supply chain, our highest-volume specialty end market. While total Orion profitability was down year-over-year, reflecting adverse geographic and product mix and pricing, these variances were partially offset by lower costs and a greater co-generation contribution. Gross profit per ton improved sequentially, thanks largely to better operating performance, enabling greater fixed cost absorption. Overall, cost improvements benefited from self-help actions which were obscured by the adverse inventory revaluation, which we had called out on last quarter's call due to lower average oil prices across Q2. On Slide 8, our rubber business delivered 7% higher volumes year-over-year and 4% higher adjusted EBITDA. The volume improvement was expected a function of the 2025 contract outcomes and would have been better if not for import-related headwinds across the western markets in which we operate. As Corning noted, imports continued to increase compared with already elevated 2024 levels. Our China business also delivered higher volumes, a function of improved plant operations there. Overall, rubber volume gains were skewed towards lower-margin regions, hence, the adverse mix dragged on the volume contribution in our year-over-year EBITDA bridge. Our gross profit per ton recovered sharply on a sequential basis in Q2, thanks mostly to improved plant performance. However, this metric would have been stronger if not for the headwinds from the elevated imports into our highest performing rubber markets. In the EBITDA bridge, you can see a strong cost performance more than offsetting price mix, thanks to better absorption, a higher co-generation contribution, and lower fixed costs despite adverse timing related to pass-through provisions. On Slide 9, in Specialty, the main issue in Q2 was soft demand due to the macro backdrop and related customer hesitancy with tariff uncertainty translating to weaker trends in manufacturing sectors, especially in our key North American and European regions. Specialty volumes were down 8% year-over-year and 6% sequentially, and the sluggish volumes were a major factor in our EBITDA bridge. Product pricing and mix was a positive contributor to EBITDA on a year-over-year basis, but profitability, including gross profit per ton degradation, was hurt by the inventory revaluation I mentioned. This transient impact, roughly $50 per ton was only partly offset by more favorable co-generation contribution and reduced costs. The euro's appreciation was late in the second quarter, so FX translation was not a major driver in our P&L results. Slide 10 shows our latest guidance reflecting the surge in import headwinds affecting our rubber segment and overall macro uncertainty impacting both segments, we are narrowing our adjusted EBITDA guidance by reducing the high end of our prior range. Note also, considering improved operations, coupled with persistently soft overall demand backdrop we anticipate production rates to further lower inventories as we drive to achieve our free cash flow commitment for the year. You can see on this slide that we are maintaining our free cash flow expectations of $40 million to $70 million or $55 million at the midpoint. Slide 11 simply shows our continued focus to reduce CapEx not only in 2025 but in 2026 as we've discovered over the past few quarters. Slide 12 shows the higher expectation for cash being extracted from working capital. We've already made substantial progress in Q2 in inventories. We expect meaningful benefit simply from the normal seasonal accounts receivable released during Q4. We have also launched initiatives which should serve as insurance to achieve this free cash flow target. After achieving our commitment in 2025, higher free cash flow conversion is a straightforward lift next year simply from lower capital expenditures. Looking forward, we have shifted our capital allocation priority from buybacks to debt pay down. That will be the priority through at least the balance of 2025 and likely into 2026. We finished the quarter with a net debt-to-EBITDA ratio of 3.55, one turn higher than the high end of our target range. I would note that the stronger euro at quarter's end increases this metric by 15 to 20 basis points due to our euro debt translation to dollar. Efforts over the balance of this year and into next year will be focused on both reducing the numerator and increasing the denominator to improve this metric. With that, I will turn the call back to Corning.

Corning F. Painter, Chief Executive Officer

Thanks, Jeff. Before moving to Q&A, let me just summarize a few key takeaways captured on Slide 13. We're pleased with the sequential earnings improvement partially enabled by our better overall plant performance. We look to build on better operating metrics through continuous improvement and manufacturing excellence programs, which, as we mentioned, are gathering momentum. Despite the in-line second quarter result, and let me be clear about this point, we by no means are complacent. Our intensified focus goes beyond simply weathering the challenging backdrop and is focused on positioning Orion to demonstrate much greater earnings power for winning the business cycle and other factors inevitably inflect in our favor. We do expect to see demand benefit from the new tariff paradigm in late 2025 or early 2026 even as our tire customers are hardly likely to acknowledge this reality as supply contract negotiations for next year progressed in earnest. Finally, I just want to reiterate that through all of this, driving free cash flow improvement remains the company's highest priority after safety at this juncture. If there are tactical decisions that improve cash flow at the expense of P&L, we will make that trade all else equal. In short, we fully intend to achieve our 2025 free cash flow guidance and setting us up for even greater free cash flow next year. And with that, Ryan, please open up the lines. We'll be happy to take people's questions. Thank you.

Operator, Operator

Ladies and gentlemen, we will now begin the question-and-answer session. The first question comes from the line of Josh Spector from UBS.

Christopher Silvio Perrella, Analyst

It's Chris Perrella standing in for Josh. I wanted to inquire about the increase in earnings for the second half of the year compared to the Q2 baseline. Specifically, how much of that increase is attributed to volume growth and how much is due to self-help initiatives? Could you elaborate on the details of your assumptions in the guidance?

Jeffrey F. Glajch, Chief Financial Officer

Sure, Chris. This is Jeff. A couple of things. First, if you remember our Q2 numbers, we had a $5 million inventory revaluation. Excluding that, Q2 would have likely been around the mid-70s instead of where we landed. Looking ahead, I don't expect a significant increase in volume. For instance, in the rubber business, I think we'll remain fairly consistent with our Q2 performance, which will still indicate year-over-year growth, but not much of a sequential increase. In specialty, we may see a slight uptick in volume, but the current market conditions present some challenges. So mainly, it's about normalizing Q2, and as you mentioned, some of the cost actions we've taken have benefited us so far, and we will continue to see that benefit in the second half of the year.

Christopher Silvio Perrella, Analyst

I appreciate the color on that. And then the question on the cash balance at the end of the year. What actions do you have? Or could you elaborate a little bit more on other levers that you have to pull yet to hit that target?

Jeffrey F. Glajch, Chief Financial Officer

Sure. So if you think about working capital, there's three levers. There's receivables, there's payables, and there's inventory. We've done quite a good job on receivables over the past couple of years starting in 2023. So not a lot there right now. The inventory, we took our inventory down, as Corning noted, $27 million in Q2. I'd say between now and Q4, I think there's more of an opportunity to take that down. It may not happen in Q3 and part of the reason would be we've got some shutdowns in early Q4, some turnarounds and when we do that, we want to build up a little inventory beforehand. So you probably won't see it in Q3, but perhaps you'll see a little bit in Q4. And then on the payable side, we've got some activities that we're looking at that. I don't want to go into too much detail yet but they may help us as we get toward later into 2025 and then also further more in 2026.

Christopher Silvio Perrella, Analyst

I appreciate that. And Jeff, enjoy the retirement.

Operator, Operator

The next question comes from the line of Kevin Estok from Jefferies.

Kevin Estok, Analyst

I'm just curious about the tariffs.

Operator, Operator

Kevin, I do apologize to interrupt you, but your audio is not coming in clear.

Kevin Estok, Analyst

Can you hear me now?

Corning F. Painter, Chief Executive Officer

A little better. I think if you can just try talking really softly or slowly, let's try that.

Kevin Estok, Analyst

Okay. So on tariffs, I was just wondering, I guess, do you expect production to initially come back to Mexico, let's say, before the U.S.? And just on the tailwind itself. Have you thought about quantified....

Operator, Operator

Kevin, again, I do apologize, your audio is not coming in clear.

Corning F. Painter, Chief Executive Officer

So Kevin, I heard the first half of that. Do we expect production to revert more to Mexico than the U.S.? No, we don't. I think it would be broadly felt. Maybe if you could try a different line and then get back in the queue, it's very hard to hear you.

Operator, Operator

We take the next question from the line of Jon Tanwanteng from CJS Securities.

Jonathan E. Tanwanteng, Analyst

I was wondering if you could talk about what you're expecting in Q4. Is it going to be the traditional seasonal downtick or if maybe there's more tariff certainty, perhaps rates are lower, inventories are drawn down, if that might be a little bit different or people might still be cautious.

Corning F. Painter, Chief Executive Officer

Well, Jon, that's an excellent question, and I wish I could provide more certainty about what will happen in Q4. There is a possibility that we could experience a stronger Q4, considering the entire tariff situation. However, I believe it's still too early to make a confident prediction at this point.

Jonathan E. Tanwanteng, Analyst

Okay. Great. Could you elaborate a bit more on the discussion about structural versus temporary factors regarding imports? Specifically, for the imported tires at the lower grades you mentioned, are the current prices, after accounting for tariffs, comparable to the prices that domestic tire companies offer to your customers? Or is there still a pricing gap due to the tariffs?

Corning F. Painter, Chief Executive Officer

Yes, I'd say there's still a price gap, and it's a little bit apples to oranges. So the domestic producers, which are the global companies, not just U.S. companies who operate in the United States, I would say they primarily associate them with their Tier 1 brands, just about all of them have a Tier 2 brand as well. And in both of those brands, they tend to be offering a tire, which comes with a mileage warranty and things like that. So the value proposition they're offering is somewhat better than, let's say, a Tier 3, Tier 4 imported tire is. So I think what the tariffs achieved, the 25% automotive tariff is it closes that gap quite considerably for them in terms of selling against it. And you do see some signs of those major premium tire companies investing a bit more advertising in their second-tier lines right now. And I think, yes, they still cost a little bit more, but they offer you more of a warranty, there's more there to sell in terms of value-add cost of ownership. Does that answer your question, Jon?

Jonathan E. Tanwanteng, Analyst

It does. I'm just curious as to if you've seen any reversion to the higher value versus the lower price in the end markets from just a consumer mix perspective or if that continues to trend towards the lower price?

Corning F. Painter, Chief Executive Officer

I wouldn't say we're like our position in the supply chain that we're going to be the first guys to see it. What I would say is that for some of the majors, their second-tier brand tire factories have performed better in the course of this year than their premium lines in terms of simply volume taken relative to plan.

Jonathan E. Tanwanteng, Analyst

Okay. Great. Last one, if I could sneak one in. Just any incremental tariff impacts from the August 1 announcements? I think you mentioned India. I don't know if there's anything else that was either a headwind or tailwind that might impact you guys. Any updates there would be helpful.

Corning F. Painter, Chief Executive Officer

So the biggest thing for our customers is simply the 25% automotive tariff, and that includes replacement tires. And that's the 232. It's a section separate item, so not really part of the reciprocal tariffs. So even somebody who has a 10% tariff rate, for example, automotive parts are subject to that. So that's, I think, a real positive, steady thing for it. There's not a lot of carbon black imported into the Americas. But in the U.S., there is some coming out of India. So I think 25% and just yesterday, another 25%, total of 50%. I'm not saying I'm sure it's going to stay at that level. But any elevated tariff level on India is also something that would make that imported carbon black from India, I think just less economically viable. I think a tariff in the 10%, 15% to 25% range would be meaningful as well in that space.

Operator, Operator

The next question comes from the line of John Roberts from Mizuho Securities.

John Ezekiel E. Roberts, Analyst

Thank you, and thanks, Jeff, for your service. On Slide 4, is the implication that the area between the 2025 import line in the upper dash line, that area represents the excess imports. So do we need to see that 2025 line go below the dash line by an equal area to rebalance the market?

Corning F. Painter, Chief Executive Officer

I believe any decrease from the levels seen in 2024 or even 2023, or going back to 2019, would indicate improvement for our customers, and when our customers perform better, we perform better. If you're referring to returning to the low 50s, that aligns with the conditions we saw in 2019. Does that address your question, John?

John Ezekiel E. Roberts, Analyst

Well, yes, just to know how far down we have to go to, you would think inventories would be, say, normalized?

Corning F. Painter, Chief Executive Officer

Well, so inventories is a different question, right? So I think inventories is this question of the surge of product came in, and that's going to have to get sold through, and that's going to be out there at the tire dealers, right, in their shops, competing with those, let's say, Tier 2 brands of the major tire companies. And our tire customers, nobody has great visibility to that. Our tire customers would say they expect that to be burned down, let's say, over the course of the remainder of this year. But in terms of tire manufacturing, the underlying signal for where this market is going, that's all about this import rate. And any downward movement in that is good and you can just pick your year and say, well, what would it be like if it was less than '22, '23 blah, blah, blah, all the way down to '19. But the speed with which it declines is probably says a little bit about how quickly the inventory gets burned down. But I think the real signal there is just for what we can expect for demand going forward.

John Ezekiel E. Roberts, Analyst

Okay. And then the Cabot transaction in Mexico seemed like a unique opportunity for them, and you earlier did the LyondellBasell transaction in Europe. Are there many other captive carbon plants around the world that we could see some further consolidation here?

Corning F. Painter, Chief Executive Officer

There is very limited potential for consolidation in the captive market. However, there may be opportunities for consolidation among some of the smaller carbon black companies that exist. Overall, the possibilities for a true captive scenario are quite constrained.

Operator, Operator

Thank you. Ladies and gentlemen, as there are no further questions, I would now hand the conference over to Mr. Corning Painter for his closing comments.

Corning F. Painter, Chief Executive Officer

Okay. Well, look, thank you again for your attention. Once again, Jeff, thank you very much for your service over the last 3.5 years. We'll miss you. We will be back out on the road meeting with investors. We'll be at the Mizuho, the UBS and the Jefferies Conferences in New York in the coming weeks, and we look forward to engaging with many of you at those events in person. So I wish everyone a good rest of your day. Thank you for your time.

Operator, Operator

Thank you. Ladies and gentlemen, the conference of Orion SA has now concluded. Thank you for your participation. You may now disconnect your lines.