Earnings Labs

Ingevity Corporation (NGVT)

Q1 2017 Earnings Call· Sat, May 6, 2017

$74.75

-2.06%

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Transcript

Operator

Operator

Welcome to the Ingevity First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session. [Operator Instructions]. As a reminder, this conference is being recorded. I'd now like to turn the conference over to President of Investor Relations, Dan Gallagher. Please go ahead.

Dan Gallagher

Analyst

Thank you, David. Good morning, everyone. Welcome to Ingevity's First Quarter 2017 Earnings Conference Call. Earlier this morning, we posted a presentation under the Investor section of our website that we will be speaking to you on today's call. If you haven't already done so, I would encourage you to download this file in order to follow along in the call. You can find it by visiting ir.ingevity.com under Events and Presentations. On slide number 2 of that deck, you'll see our disclaimer that today's earnings call may contain forward-looking statements. Relevant factors that could cause actual results to differ materially from these forward-looking statements are contained in our earnings release and in our SEC filings, including our Form 10-K and our most recent Form 10-Q. Ingevity undertakes no obligation to publicly release any revision to these projections and forward-looking statements made during this call or to update them to reflect events or circumstances occurring after the date of this call. As a reminder, the Company has made certain revisions to previously-issued financial statements. These revisions can be found in our news release issued yesterday afternoon. Throughout this call, we may refer to non-GAAP financial measures, which are intended to supplement not substitute for comparable GAAP measures. Definitions of these non-GAAP financial measures and reconciliations to comparable GAAP financial measures are included in our earnings release; it can be found on the Investor Relations section of our website. Our agenda is on slide number 3. With me today are Michael Wilson, President and CEO; and John Fortson, Executive Vice President and CFO. First, Michael will comment on the highlights of the quarter and then he will review the performance of our two segments. John will discuss our current financial status and guidance. Then, Michael will make some brief closing remarks before we open up the phone lines for our Q&A session. Joining Michael and John during the Q&A portion of the call will be Mike Smith, President of Performance Chemicals; and Ed Woodcook, President of Performance Materials. With that, I'd like to turn the call over to our President and CEO, Michael Wilson.

Michael Wilson

Analyst

Thanks, Dan, and good morning, everyone. Thank you for joining us this morning and for your continued interest in Ingevity. If you turn to slide number 4, you will know some highlights for the quarter. As you can see, we're off to a solid start to the year. We delivered a significant increase in revenues of approximately 9% versus the previous-year's quarter by driving volume growth in a range of our businesses, including the Performance Materials segment and in sales to oilfield and Industrial Specialties applications within Performance Chemicals. Adjusted EBITDA of $50 million was in line with our expectations. When compared with the particularly strong previous year's quarter while still part of WestRock, our adjusted EBITDA increased by approximately 4%. Our adjusted EBITDA margins of 23% were moderately lower than the previous year's quarter. Yes, they were slightly higher than the 22.3% in the full year of 2016. In addition to the volume gains, the Company is benefiting from a significantly lower cost structure resulting from the cost reduction initiatives implemented in 2016. We also had lower raw material costs, predominantly in our Performance Chemicals segment. These positive impacts were partially offset by unfavorable price and mix, negative foreign currency exchange impacts and additional standalone costs versus the prior year quarter. As you can see on slide 5, we have a more positive story to tell on Performance Chemicals that has been the case as of late. The team delivered an encouraging rebound this quarter. Segment sales in the first quarter were $135 million, up approximately $6 million or about 4.3% versus the prior year. This was driven by increased volumes and sales to industrial specialties and oilfield applications. Sales into industrial specialties applications and these include printing inks, adhesives, agricultural chemicals, lubricants and others, were up approximately 2%.…

John Fortson

Analyst

Thank you, Michael. Good morning, everyone. If you turn to page 9, I will provide some additional color on the results, review our capital structure and briefly discuss our guidance before turning the call back to Michael for some closing remarks. As Michael has said, the first quarter was a solid start to the year. Revenues were up 9.5% and EBITDA was up almost 4% versus the first quarter of last year. This is a good outcome versus the first quarter of 2016, which is the tough comparable period. During the first quarter of last year, the Company had a one-time FX gain of approximately $3 million that was a result of marking to market certain liabilities while establishing the various standalone Ingevity legal entities around the world. Additionally, the company's cost structure in both SG&A and cost of goods sold was low that quarter, as we were just beginning to hire talent and invest in standalone infrastructure in advance of the spinoff. And finally, the Performance Materials segment had an extraordinary quarter and produced an EBITDA margin in excess of 48%. Last year, the segment had only a minimal outage in the first quarter versus that was a much more significant outage this quarter in Wickliffe. Also, this year, the ramp-up in Waynesboro is more impactful. When we account for all these factors, we are pleased with the first quarter of 2017 operating results. Net interest expense for the quarter was $3.3 million. Net interest expense in the first quarter of 2016 was based on allocations from WestRock and therefore is not a comparable period comparison. It is also worth noting that since the quarter end, we are entering into a cash pool bank account structure to manage some of our intercompany FX exposure between subsidiaries. In lieu of…

Michael Wilson

Analyst

Thanks John. As both John and I've said, we're pleased with the quarter's results. But nothing has significantly changed in terms of market dynamics that would alter our view of the year. I'm even more confident about our ability to achieve the guidance numbers we set forth. We are continuing our focus on implementing our growth strategies, while operating efficiently and holding the line on costs. We expect to turn in a strong performance in 2017, with near double digit adjusted EBITDA growth. We continue to believe very strongly in the potential for our company. We hope you share enthusiasm for Ingevity. At this point, operator, we'll open up the call to questions.

Operator

Operator

[Operator Instructions] Question from the line of Mike Sison. Please go ahead.

Mike Sison

Analyst

Hi guys. Nice start to the year.

Michael Wilson

Analyst

Thanks Mike.

Mike Sison

Analyst

In terms of Beijing, just curious when would your technology start to become specified or -- are you having conversations now with OEMs there to help meet standards in that area?

Michael Wilson

Analyst

Yes Mike. We've been working with OEMs for some period of time to prepare for the implementation of the national regulations in China. I think specifically as it relates to Beijing, what's new this quarter is the announcement by the Hebei province, which again excludes Beijing, but surrounds it that they're going to implement early, about 18 months early. So the impact for us is that it probably pulls forward some demand growth into the beginning to first half of 2018, in order to be able to supply those customers.

Mike Sison

Analyst

Got it. And for Performance Chemicals, the results were solid, any thoughts on that business as the year progresses? Is it may be coming a little bit better? Do you kind of feel that there's a bottom kind of supporting the business at this point?

Michael Wilson

Analyst

We're certainly hoping that we're past the bottom. I think clearly, we had a strong first quarter, which was a nice rebound and we're anxious to see how the rest of the year unfolds. We know that we're going to be supported as we go through the year with the lower cost structure that we put in place. We also know that as we move to the second half of the year, our CTO savings are going to become more significant. And then of course, our pavement business is very seasonal. So the second and third quarters will be very significant for that business.

Mike Sison

Analyst

Great. Thank you.

Operator

Operator

We now have a question from the line of Ian Zaffino from Oppenheimer. Please go ahead.

Mark Zhang

Analyst

Good morning guys. This is Mark Zhang on for Ian. Thanks for taking the question. I also wanted to follow-up a little bit on the performance chemicals segment. So, I guess with the recovery, how do you -- how should we think about, I guess, number one, the topline performance going for the balance of the year? And is there more recovery on the oilfield or the industrial side and also, mergers going forward, how should we think about that? Thank you.

Michael Wilson

Analyst

Yeah Mark. Thanks for the question. I think the best way to think about it is, if you think about the two primary bio-fractions that we talk about coming off the bio-refinery from the CTO, the TOFA and the TOR, clearly, there has been an improvement in the demand for TOFA. A lot of that -- a majority of that has been driven by increased demand in the oilfield sector, as activity has increased. Our outlook is that, that activity should be sustainable throughout the balance of 2017. So supply-demand economics in TOFA are -- have turned clearly and are more favorable. The other side of the business, the TOR side or rosin side of the business continues to see significant pressure by oversupply. So pricing there is under pressure. So I think we just have to see how the dynamics unfold for both of those bio-fractions. And again I think the health of the oilfield sector as well as how strong a paving season we have, will have a lot to say about the performance of our Performance Chemicals segment for the full year.

Mark Zhang

Analyst

Okay, terrific. That's very helpful. And then I guess just to confirm that, with stronger volumes now, when will you guys -- I guess, expect to see a potential rebound on the pricing side?

Michael Wilson

Analyst

Well, as it relates to TOFA, as I mentioned in the prepared remarks, we've already implemented or in the process of implementing a price increase of $120 per ton for TOFA and TOFA derivative products. That price increase was effective April 1. So there was really no benefit of that in the first quarter. And it's really too early to say what the overall impact will be for the full year. But early indications are, is that the increase is getting traction. So we expected to provide some benefits to us as, we progress through the second, third and fourth quarters. Again on the rosin side, still pricing under pressure, and it remains to be seen when we're going to see that turn around.

Mark Zhang

Analyst

Great. Thank you guys very much. Great quarter.

Michael Wilson

Analyst

Thank you.

Operator

Operator

We now have a question from the line of Jim Sheehan from SunTrust. Please go ahead.

Jim Sheehan

Analyst

Good morning. Thanks for taking my questions. In activated carbon, you mentioned some outage costs, maintenance costs in the quarter at the Wickliffe plants. I think you also mentioned Waynesboro. Could you talk about the magnitude of those costs in the first quarter and if any of those costs will carry through into the second quarter?

Michael Wilson

Analyst

Yeah Jim. Thank you for your question. In terms of the Wickliffe outage, this was originally an outage that we planned in the second quarter, but we moved it forward into Q1. The outage was significant, but not a major outage. I think the total outage time was around 10 days. So I would say the impact of that is probably low single digits millions of dollars. In terms of the costs that we're seeing at the Waynesboro facility, as we've talked about, we're essentially in the process over a two year period of time quadrupling the capacity of that facility. So we bring on additional capacity, additional shifts at various increments. So that's the additional cost that we're experiencing in Waynesboro. That operation is less capital intensive than our primary carbon plants, has more manual labor. So you've got more direct costs.

Jim Sheehan

Analyst

Great. And then staying in activated carbon, when we look at how the China market is developing here? Could you talk about how your discussions are going with OEMs for the 2020 implementation period? And also address what your market share is today in China and where do you think that's going over the next two or three years?

Michael Wilson

Analyst

Yes Jim. I think Ed Woodcock is probably the best person to provide color on that. Ed, you want to comment?

Ed Woodcock

Analyst

Sure. Good morning Jim. The China market has been preparing for these new regulations for probably the last four years, as the EPA of China had been discussing with the OEMs of their intentions. So we've been working with these OEMs for a number of years. And as a reminder, as the regulatory technology or package increases in complexity, it benefits our business where we have a higher product set, a higher technology product set. So we are seeing an extremely good adoption rate for our business so far. We also expect that it's going to be biased towards our higher 15 BWC products. I think the OEMs in general though because they've been working on this for a number of years, are ready to meet the demand in 2018. Some of them, eventually more China-oriented OEMs would probably be better able to meet that demand in 2019. So I think based on what Hebei province did, they first recognized that the automobile suppliers are capable of being able to meet that earlier adoption and they felt comfortable with moving that forward to January of 2019. So we still expect other cities to as well announce some earlier adoption rates and will be updating you as those occur.

Michael Wilson

Analyst

Jim, this is Michael Wilson again. As you know, we don't comment specifically on market share, but what we have said is that in the China market, we do have a majority share. Though that level of share is much lower than we have in North America and other regions, and we do expect our share of market to increase, as the regulations are implemented for all the technology reasons that Ed intimated.

Jim Sheehan

Analyst

Thanks and Ed, to follow-up on that. The 15 BWC grade that you say, that the OEMs are biased towards, could you explain what's motivating that bias and if they class the OEM more to have higher technology products, obviously that would cost them more. Why would they want to pay more for it.

Ed Woodcock

Analyst

Yes. This again is a new technology for China and so there is a very much an opinion from the OEMs and the [indiscernible] suppliers to minimize their risk, relative to this new technology. And as they implement ORBR standards and they will be following forward with adding technology, so that they have a substantial safety factor relative to the emissions. I'd also add that China with this new regulation has installed a high level of penalties for not meeting the regulation. And so that drives that greater content and that greater safety factor as well.

Jim Sheehan

Analyst

Any idea what that penalty might be?

Ed Woodcock

Analyst

Yes, it's pretty big and it's per vehicle. I think we can get you those details at a later date, if that's okay?

Jim Sheehan

Analyst

Great, thank you very much, gentlemen.

Operator

Operator

And next, we go to the line of Mark Weintraub with Buckingham Research. Please go ahead.

Mark Weintraub

Analyst

Thank you. And first, just can you give a sense of the approximate tonnage on the TOFA? You mentioned about $120 per ton price increase, how much tonnage would that potentially impact?

Michael Wilson

Analyst

Mark. We typically don't give out the specifics around volumes in terms of tons, [inaudible] I think that we did disclose our total purchases historically of CTO or processing capacities about 300,000 tons, a year that we process. And if you think about the two primary bio-fractions of TOFA and TOR, they probably make up close to 80%.

Mark Weintraub

Analyst

Okay. That's helpful. And if in fact you do get the pricing in TOFA -- at some point, does it make more sense to be producing more, even when the TOR market is soft or just -- the economics are such, is really the limiting factor is what goes on with TOR?

Michael Wilson

Analyst

Yes. Given where the market pricing is today and the various value streams for TOFA and its derivatives and derivatized TOR, it makes sense to base the refineries on meeting the demand that we have for the TOR or rosin products as opposed to TOFA. We would need to see TOFA prices continue to increase pretty substantially before we would change the calculus and say it makes sense to run the TOFA demand.

Mark Weintraub

Analyst

Okay. And then you had mentioned that -- you could be generating higher free cash flow -- you reiterated your prior guidance, but mentioned that you could be generating higher free cash flow. Is that -- would that be coming from the earnings side, CapEx, working capital, can you give us a flavor as to what the driver that you're most focused on that could be contributing to the potential for higher free cash flow would be?

John Fortson

Analyst

Hey Mark, it's John. I mean, it's really a combination of operational performance and working capital management. If you think about our business model, right, when we get the CTO that's going to come out all the time and we make decisions on whether to run it through the refinery or not, based on demand. And so we're constantly assessing those different variables. But as we sit here today and you kind of look at where our inventories are moving and where our demand schedules are, we think we're going to put in -- we're going to have a very strong year. It's early. That's why we haven't changed the number. I mean, second and third quarter are pretty important for this company. But we feel good sitting here today.

Mark Weintraub

Analyst

And then, on the China, can you sort -- how is this Zhuhai -- I probably pronounced that close to, right-- how that facility is doing? Is that contributing financially yet?

Michael Wilson

Analyst

Things are going well at Zhuhai facility. We have a number of customers who have been qualified and that we're supplying from that facility. But there are customers who are outside of China at this point in time. It also is continuing to ramp up to its full nameplate capacity, and to some degree, we're using it to build inventory ahead of -- which is going to go against some of the working capital initiatives we have elsewhere. But we're building some inventory ahead of the demand in China that we know is coming. But I would say at this point we're still operating at relatively low utilization rates and I would think of it as sort of breakeven profitability for 2017.

Mark Weintraub

Analyst

And maybe last one, as you mentioned 2Q, 3Q, the big quarters, I think you mentioned also paving being an important variable in that too, when do you start having a read -- a pretty good read on how it will play out? Are you already getting that sense now or is it still a little bit early?

Michael Wilson

Analyst

I think we're just at that point. So over the next 30 days or so, we're probably going to know a lot more about how strong the North American paving market is going to be. At this point, again, everything is sort of consistent with our outlook and guidance.

Mark Weintraub

Analyst

And what would tend to be the kind of key determinant that is going to push it one way or the next that you're going to kind of learn in the next 30 days -- would you say?

Michael Wilson

Analyst

Really, when you think about that business, it's kind of project by project in terms of paving and construction. So it really depends upon what projects that State Department of Transportations and municipalities bring forward for implementation. And then I'm always loathed to mention this, but weather plays an impact in terms of when they start those various projects and whether they get them completed. I think we talked about it in the fourth quarter that a number of states had approved budgets for infrastructure spending that were favorable. The one thing that remains a frustration to us is going back to, I think, 2015, the FAST Act was passed which was supposed to provide for greater infrastructure spending at the federal level beginning 2016 and it was supposed to increase infrastructure spending, I think, by 4% in the first year and 2% in each subsequent year. That's a law and it's on the books, but it's never been funded, because they continue to fund the government through reconciliations as opposed to passing a budget.

Mark Weintraub

Analyst

Okay, great. Thank you.

Operator

Operator

Next, we have the line of Jon Tanwanteng with CJS Securities. Please go ahead.

Jon Tanwanteng

Analyst

Good morning, guys, nice quarter. And thank you for taking my questions.

Michael Wilson

Analyst

Thanks Jon.

Jon Tanwanteng

Analyst

If possible, can you clarify what's built into your guidance in terms of total U.S. auto sales, the adoption rate of Tier 3 products and the mix of vehicles by gas tank size?

Michael Wilson

Analyst

I don't think we're going to get into that level of granularity. What I did mention in the prepared remarks is the current forecast for North American automobiles for 2017 and those forecasts are consistent with the assumptions that are embedded in our guidance. So in terms of the overall production and sales, I think we're comfortable with the current outlook for the North American market. In terms of the adoption rate, we believe basically they're on trajectory that they met the 40% implementation required for 2017 and that they will be right there at 60% for 2018 model year vehicles. In terms of the gas tank sizes, I guess I would just point you back to the information that we talked about, that North American consumers are continuing to favor trucks and SUVs over passenger vehicles or cars, and I think we gave some market share changes among those vehicles in the remarks.

Jon Tanwanteng

Analyst

Okay, great. Thanks. Moving to the China side, any sense of how many cars are sold in Hebei and the relative demand from the other areas that are considering pulling forward the adoption standards?

Michael Wilson

Analyst

Yes. I think in the Hebei province itself, it's about 1.5 million vehicles, annually new vehicles are sold. In Beijing, that Hebei surrounds and Beijing has not announced anything yet, it's closer to 0.5 million.

Jon Tanwanteng

Analyst

Got it. And then any update on potential competitors in the carbon segment either approaching on the level two or level three standards? Is anyone catching up to from a technology perspective at all?

Michael Wilson

Analyst

Ed, you want to take that?

Ed Woodcock

Analyst

Yes, you're right. I talked about earlier -- with the technology shift to OR-VR, it is pushing more volume towards our higher performance products. We feel we have a major market share today and we think that will continue to grow with that shift to greater technology.

Michael Wilson

Analyst

Yes, Jon. Relative to the U.S. on the Tier 3 LEV III, again we have intellectual property that provides us protection in that marketplace through 2022.

Jon Tanwanteng

Analyst

And finally, just any update on the use of cash and potential for M&A?

Michael Wilson

Analyst

I think in terms of the use of cash. John gave some comments regarding what we expected from a leverage standpoint as we go through the year. In terms of capital allocation, again, our priorities are first and foremost, to continue to invest fully in our businesses, particularly in the Performance Materials side of the business. We don't think there's anywhere that's going to give us a better or higher return than that market segment. We are interested in inorganic growth. We said previously, we believe there're opportunities both in the Performance Materials as well as the Performance Chemicals space. The opportunity set frankly is probably a bit broader in chemicals than materials, just because of the niche in which we compete on the material side. But we do believe that there're opportunities that will be value creating for shareholders. We have a process in place and we're actively screening for opportunities. Obviously, can't comment on anything specific, but at the end of the day we're going to find value creating opportunities to invest or otherwise, we're going to return the cash to shareholders because it is their cash after all.

Jon Tanwanteng

Analyst

Great. Thank you very much.

Operator

Operator

[Operator Instructions]. We do have a question from the line of Daniel Rizzo with Jefferies. Please go ahead.

Daniel Rizzo

Analyst

Good morning guys. Just with pavement technologies, can you just discuss, I guess, the interest level or adoption for Evotherm and new product that it seems to have a lot of added benefits?

Michael Wilson

Analyst

Sure Dan. I am going to let Mike Smith comment on that.

Mike Smith

Analyst

Thanks Dan. We continue to be very excited about the prospects for Evotherm technology. We saw strong growth in that technology last year, and based on the initial projects that we have going on this year, we see continued growth. There are a number of important value drivers that our customers can benefit from, with Evotherm and they are increasingly interested in working and using them in terms of lower temperature types of asphalt applications.

Daniel Rizzo

Analyst

Okay. And then with TOFA, is there any -- I mean what needs to happen for, I guess, for the capacity constraints to ease or for the supply issues to kind of pull back? I mean what would have to happen in the future?

Mike Smith

Analyst

I'm not sure I fully understand your question. We are seeing a significant uptick in demand for TOFA, and pretty dramatic turnaround to be honest with you. We've gone from a position where in the fourth quarter of 2016, we were long on supply. We had substantial inventories, a big uptick, particularly from oilfield activity has really moved us from a long to a short position. And we're probably going to -- our view is, that that will probably continue to be short, because we think the demand for TOFA is going to outstrip supply, again because of the discussion we had around the economics of the bio-refinery, which really dictate that we should run to rosin demand instead of the TOFA demand. So in this scenario, we will take the volumes of TOFA that we're producing and place those in their highest value added applications. Really, we're the ones who are going to realize the most price [ph].

Daniel Rizzo

Analyst

Excellent. That makes sense. Thank you for the clarification. Thank you.

Operator

Operator

And at this time, there are no further questions in queue.

A - Mike Smith

Analyst

If I could just add one more comment to Dan's question on TOFA, I think the other thing that's important is we talked about -- we prefer to derivatize both the TOFA and the TOR as opposed to selling it directly as TOFA. Those derivatives create more value for our customers and allow us to capture more value. So one of the ways that we can increase volume and increase revenue given the fixed amount of the raw material that being TOFA or TOR is by derivatizing it, because the derivatives will have less than 100% of TOFA content. So that's something that we're interested in, and as now we're in a tight supply position, we're favoring that, and that's occurring now particularly in oilfield. Thank you.

A - Dan Gallagher

Analyst

So operator, I don't know if there are any other questions?

Operator

Operator

We do have another question from Daniel Rizzo with Jefferies.

Q - Daniel Rizzo

Analyst

Sorry for the confusion. So just to follow up with TOFA and how you prefer to derivatize, is there a significant step change in price that would -- I mean that you can quantify or just kind of provide color on?

A - Michael Wilson

Analyst

Well, there is certainly is a price level for TOFA, of which the economics of running the bio-refinery would favor TOFA over TOR. However, we're a long way from that, so while we have optimism about the price increase and we are also certainly glad to see that we're getting back to a point where demand has increased, and we have some pricing leverage. I think we need to keep in perspective, the fact that TOFA pricing today is still well below the levels that it needs to be or sort of reinvestment economics.

Q - Daniel Rizzo

Analyst

All right. Thank you.

Operator

Operator

And at this time, there is no further questions in queue. End of Q&A:

Michael Wilson

Analyst

Okay. I just like to thank everyone for your time and interest this morning. We remain very positive about the long-term outlook for Ingevity, and we look forward to talking with you again next quarter. Have a great day.

Operator

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank for your participation and for using AT&T Teleconference. You may now disconnect.