Ingevity Corporation (NGVT) Q2 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Ingevity Second Quarter Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, we'll conduct a question-and-answer session [Operator Instructions]. And as a reminder today's call is being recorded. I'd now like to turn the conference over to Mr. Dan Gallagher. Please go ahead.

Thank you, Art and good morning everyone. Welcome to Ingevity's Second 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 on 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 advised guidance. Then, Michael will make some brief closing remarks before we open up the phone lines for our Q&A. 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.

Thanks, Dan. 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 note some highlights for the quarter. We delivered strong financial results in the second quarter. Revenues grew by $15 million or little over 6%, while adjusted EBITDA at $67 million was up versus the prior year's quarter by approximately 15%. Halfway through the year our Performance Materials segment is realizing the growth we anticipated in the global automotive markets. In addition, we're achieving better than expected results in our Performance Chemicals segment due to the team's strong execution as well as improving market fundamentals. Revenues and earnings were driven predominantly by volume gains. Earnings were further augmented by the lower cost structure we put in place via strategic initiatives over the last 18 months, lower raw material costs, particularly for Crude Tall oil or CTO and manufacturing efficiencies. These positive impacts were partially offset by higher SG&A costs and negative foreign currency exchange impacts. If you recall from last quarter, we began to see more positive results in our Performance Chemicals segment. As evident on slide number 5, that trend continues in the second quarter. Segment sales in the second quarter were $171 million and were essentially flat versus the prior year, as gains in sales to oilfield applications were offset by lower sales in industrial specialties. Despite flat revenue, we grew segment EBITDA by 10% due to higher oil oilfield volumes, lower raw material costs, particularly CTO and higher manufacturing efficiency. Segment EBITDA were $31 million, up $3 million versus prior quarter. This translated into a segment EBITDA margin of 18.4% for Performance Chemicals. While the second quarter is a seasonally strong quarter for this business, this result underscores the potential profitability we see for it going forward. Sales into industrial specialties applications and these include printing inks, adhesives, agricultural chemicals, lubricants and others were down about 5% as tall oil fatty acid or TOFA availability was constrained due to strong demand in oilfield and pavement applications. As demand increases for higher value derivatized products sold into our other applications, it inherently has an impact on the quantities of TOFA available to industrial specialties end users. In addition, we continue to see soft rosin demand and price pressure due largely to tapering demand for printing inks. As we discussed last quarter, since TOFA and rosin are produced in fixed ratios and since we run our refineries at a rate that matches rosin supply to demand, we expect our production of TOFA to remain limited and short of demand for the balance of the year. Much like last quarter however, we're continuing to see strong demand and some smaller niche applications such as agricultural chemicals. Our agricultural products are liven based derivatives which provide valuable disperse on properties for our customers. Sales of oilfield technologies products were up again sharply. We experienced 35% increase in revenues versus the prior year quarter. In addition to increased TOFA sales, we've been successful in executing our strategy to convert customers to higher value derivatized TOFA based products. We've also successfully increased TOFA pricing due to tighter supply and demand conditions, though pricing remains below prior year levels. Growth stand from the continued rebound in the US drilling market. US rig count as of June 30, increased to 940, compared to 431 in the prior year and 824 on March 31. Anecdotally, our teams are seeing improvements in rig efficiency, which could begin to slow the pace of growth in rig count going forward. Sales in pavement technologies for the quarter were down approximately 1% versus the prior year's very strong quarter. Due to weather, we saw a later start to the North American paving season this year. However, strong oil patterns began to emerge in June which in fact was an all-time record month for the business. Also, declining raw material costs and new products are helping to drive even stronger gross margins for pavement technologies. In addition, we experienced improved profit margin in China for pavement technologies products, albeit from a small base as we restructured our go-to-market approach in China, which is more aligned with the current market opportunity. So as you can see we're starting to realize the benefits of an upturn in our Performance Chemicals segment as a result of our own strategic actions and improved planned chemicals supply demand dynamics. Summarized on Slide 6, our Performance Materials segment once again delivered outstanding financial results. Segment's sales of $90 million were up 15 million or 21% versus the second quarter of 2016, due largely to increased volumes. Segment EBITDA of 36 million were up about $6 million or over 19% versus the prior year. Earnings were aided by the scale up and increased utilization of our Zhuhai, China facility were partially offset by plant spending and supported higher volumes. Segment EBITDA margins of 40% were down slightly year-over-year. This delays the operating performance of the segment as earnings on higher net sales were negatively impacted by foreign exchange translation losses during the quarter. Excluding, intercompany FX impact, EBITDA margins in the Performance Materials segment were 42.3% versus 40.7% in the prior year period. John's going to provide more details on this in a few minutes. Adoption of Ingevity's solutions for US Environmental Protection Agency Tier 3 and California LEV III near zero evaporative standards for gasoline vapor emission control drove this increase. Our solutions include our honeycomb scrubbers made at Purifications Cellutions joint venture and our activated carbon sheets. Tier 3 LEV III adoption appears to be on track with mandated levels as auto makers and their suppliers make the necessary platform changes for 2018 model year vehicles. As a reminder, at least 60% of all 2018 model year vehicles must comply with the near zero evaporative standard. Generally increases in light vehicle sales are additional benefit to this business. However U.S. auto sales are weakening slightly from last year's record 17.5 million vehicles. That said forecast remains intact for 16.9 million, 17.1 million vehicles to be sold in the U.S. in 2017. Currently the industry is working on inventories and alignment with these forecasts. Partially offsetting the marginally declining sales rate, we're continuing to see a beneficial shift to larger vehicles which use higher quantities of our products. The second quarter of 2017 light trucks comprise 63% of light vehicle sales, while the second quarter of 2016 they comprised 59%. All of these assumptions are embedded in our revised guidance. Turning to slide number seven, you may have seen that last month we announced that we will be building a new activated carbon extrusion plant in Changshu, China. This state-of-the-art extrusion facility is a key component of our multi-year expansion plan to support growth in this business and includes additional investments in extrusion capacity and a likely Brownfield activated carbon capacity increase in Covington, Virginia by 2019 or 2020. The Changshu plant is a capital efficient investment in our capability to turn lower margin made carbon powder into higher margin automotive products. The new plant represents an investment of approximately $20 million just over half of the expenditure is planned capital spending that will be incurred in 2018. This project is part of our existing long-term plan. The plant is expected to be operational by the fall of 2018 and will employee about 80 people, will initially feature one extrusion line and will complement our existing extrusion facility in Wuijang, China. The facility will be able to accommodate an additional extrusion line of demand warrants. At this point, I'd like to turn the call over to John Fortson, our Executive Vice President, CFO and Treasurer for a more detailed review of our financial status and outlook. John?

Thank you, Michael. Good morning, everyone. There are three areas I will cover. First, I will provide some additional color our financial performance in the quarter and over the first half of the year. I will review our cash generation and capital structure. And last, I'll provide some details on our revised guidance. As Michael discussed, the second quarter was strong. Looking at the income statement on slide eight, there are a few items worth noting beyond what Michael has already covered. First, in addition to a strong second quarter, our year-to-date performance has also been solid. Revenues of $479 million for the first half were up 7.6% from the prior-year period and adjusted EBITDA of $117 million for the first half or up 10% when compared to last year. Adjusted EBITDA margins improved 50 basis points when compared to the first half of the prior year. This half year comparison is inclusive of a tough comparable period due to the strong first quarter 2016 EBITDA on the Performance Materials segment, which we discussed on our last call. Overall, like our second quarter, the first half of 2017 reflects the continued strength in our Performance Materials segment and improvement in our Performance Chemicals segment. Second, as Michael mentioned, segment EBITDA margins for Performance Materials of 40% were 40 basis points lower than the same period last year. However when you adjust for inter-company foreign exchange exposure, the Performance Materials segment improved its EBITDA margin by 160 basis points over the second quarter of last year. This inter-company FX exposure is a result of loans between our Belgian and Chinese entities that were put in place as a part of the separation of Ingevity from our former parent. Over the course of this year, the weakening RMB has negatively impacted our margins. We have subsequently on May 22, put in place a cash pooling bank account structure in Europe that will eliminate the impact of these currencies moves on EBITDA going forward. Third, you'll know that from the second quarter of 2017, we reported net interest expense of $2.8 million. Due to reduction of our net debt to EBITDA ratio, the pricing for our revolver and term loan will fall an additional 25 basis points starting in the third quarter. Net income attributable to Ingevity was $32 million. This translated to diluted earnings per share of $0.76 for the quarter, adjusted diluted earnings per share were $0.78. This represents a 16% increase in diluted adjusted EPS both on a year-over-year quarterly comparison as well as when comparing the first half of this year to the comparable period last year. On a GAAP basis, these increases are 33% and 53%. As of June 30, Ingevity has 42.1 million basic shares outstanding and 42.4 million diluted shares outstanding. Starting in the second quarter, consistent with our commitment to offset employee stock award dilution, we purchased 12,400 shares of our common stock at a weighted average cost per share of $0.57. On slide nine, you'll find some key balance sheet and cash flow information. As of June 30, our net leverage was 1.8 times. Total debt was $481 million, including our capital lease obligation amount of $80 million related to the Wickliffe IDB. This is down from $570 million of total debt a year ago. We finished the quarter with $41 million of cash and an additional $70 million in our restricted investment account for the IDB. As of June 30, $297 million of our $400 million revolving credit facility was available to us. We have been tightly managing our working capital through our growth and we are appreciative of the work done by our SNOP [ph] and supply chain teams in this regard. In an environment where sales grew by $15 million from the comparable period last year, net inventories were reduced. This is despite the fact that we are building inventory at Performance Material products in China to fulfill the anticipated demand in that country and is due to reductions of raw material prices primarily CTO in the Performance Chemicals segment. Accounts receivable were essentially flat and accounts payable fell $13 million. The prior-year account payable balance includes certain one-time payments due to WestRock following our separation. Excluding these amounts, the accounts payable balance year-over-year was essentially flat. We generated strong cash from operations in the second quarter as our Performance Materials segment continues to become a larger portion of our business and the profitability in our Performance Chemicals business improves. Working capital management coupled with the strong cash from operations, let the free cash flow in the quarter of $35 million and $31 million generated for the first half of the year. Our capital expenditures in the first half of the year were $22 million, $12 million of which was spent in the second quarter. As a reminder, our CapEx spending is weighted towards the back half of the year due to the timing of major outages. Additional financial information will be available on our 10-Q which we expect to file later today. Turning to slide 10, we are raising our guidance for fiscal year 2017 for sales of between $940 million and $955 million and adjusted EBITDA of between $220 million and $230 million. At the midpoint, this implies year-over-year growth of 4% and 11% for sales and adjusted EBITDA respectively. Over the next two quarters, we anticipate continued sales and margin growth in both our Performance Chemicals and Performance Materials segments when compared to last year's comparable periods. We expect sales and margins in our oilfield applications to remain solid as well as a strong finish to the paving season. Additionally, we are benefiting from our cost reduction initiatives, reduced raw material costs and both plant and supply chain efficiencies. The continued sales of our EPA Tier 3 California LEV III solution to meet the regulatory requirements for passive auto emissions in the U.S. and Canada will result in continued growth and accelerated margin accretion in the Materials segment in the back part of this year, particularly in the fourth quarter. Partially offsetting these positive trends is expected reduced auto production levels. These tailwinds will also be partially offset by normal seasonal impacts including the end of the paving season and the end of the year auto production slowdowns, which results in reduced operating throughput and significantly lower sales and profitability in our fourth quarter. Additionally, we will be impacted by planned maintenance outages at several of our facilities which occur in the back half of the year. We are lowering our expected tax rate to between 32% and 34% as we have reduced operations in jurisdictions where we were unable to take advantage of tax losses. We remain focused on continued improvement within our tax planning processes. We are also lowering our expected CapEx for the year to between $55 million and $60 million. Our operations teams continue to be very disciplined in capital spending. Due to this reduction in anticipated CapEx and the strength of our cash from operations including working capital management, we are raising our expected free cash flow generation estimate to be between $100 million and $110 million for the year. We expect to finish the year with net debt to EBITDA excluding the trust lease obligation and the associated restricted cash of approximately 1.5 times. We remain focused on disciplined execution across the company for the remainder of the year. I will now turn the call back to Michael.

Thanks, John. In closing, this was a very good quarter for us marked by continued rebound in Performance Chemicals and continued strong growth in Performance Materials. We're confident in our ability to get our revised guidance. And as such, we expect to turning a strong performance in 2017 with double-digit adjusted EBITDA growth at the midpoint of our guidance. We continue to believe very strongly in the potential of our company, our enthusiasm for Ingevity. At this point, operator, we'll open up the call to questions.

Thank you. [Operator Instructions] Our first question is going to come from the line Jon Tanwanteng from CJS Securities. Please go ahead.

Good morning, gentlemen. Very nice quarter.

Thank you.

Thank you.

The portion of profits that went to the honeycomb JV from Q1, does that mean honeycomb sales decreased sequentially at all and is any research to adoption rates?

No, it's just a matter of timing of revenues.

Okay.

Again we caution this every quarter, but you really have to be careful about looking at our business on a quarter to quarter basis. We encourage you to look at the full year.

Okay. Fair enough. And then when we look at the margins in the Chemicals segment, I believe the bulk of the improvements in input cost is actually going to happen in the back half of this year. Should we still think of margins as improving sequentially going forward in that segment or what were the puts and takes to that?

Consistent with what we said historically, we believe that we're going to return this business as historical 18% to 20% margins from the 13% margins, EBITDA margins that we've earned in 2016. I think we're going to see a meaningful move in that direction when we get to year end 2017 and I expect to continue to increase in as those margins to get to that historical rate which I believe we'll now achieve by 2019.

Got it. Thanks. And then just on the oilfield side, do you see rig counts taking care, you also mentioned increased efficiency in that segment or both of those built into your guidance?

Yeah, I mean I think we have sufficiently conservative guidance built into our forecast. There's no question that if you follow the rig counts, I mean after strong growth over the past 12 months sort of month to month, the growth rate in the rig count has been slowing as of late. I think part of that is due to the efficiency that they're driving in rig productivity. Obviously is going to be dependent upon what happens to the oil prices. Based on our view of the marketplace, we're confident that we're going to continuing to see strong demand for our products through the end of this year at a minimum. I think as we go into 2018, we'll update that forecast as we have a better sense of where oil prices and other factors are trending.

Okay. Great. And then any update to the role that of or point of emission standards in China by a province basis.

There's no update. Since our last quarterly call we now for that time that Hebei province had indicated that they were going early. To date, no other province has announced a similar intention. And this is not something that we want to speculate on but we will certainly pass along the info as soon as we're aware of it.

Great. I'll jump back in queue. Thank you.

And our next question will come from the line of when a Mark Weintraub from Buckingham Research. Please go ahead.

Thank you. Two quick ones, one, I just wanted to make sure I got the pre-caps are obviously a very big increase there, $20 million. It seems like about $5 million maybe is higher net income, $5 million lower CapEx and then $10 million the improved working capital, is that about right?

That's about right. We, Mark, had going into the year as we projected our inventory levels and working capital, I think we were taking a very conservative posture given the business environment, but as we see an improvement in the Chemicals segment, we've been able to sort of manage through that and they've done a great job kind of managing inventories and freeing up cash as we've seen in their recovery so.

Okay, great. And when would you potentially get any sense when - what plan of U.S. carmakers would have for next year and in as much as we're going to have the new regulatory the 80% kicks in 2020. So in theory, they could do not a lot in 2018 or they could kind of continue along a path in 2018 and do half of it in 2018 and a half of it in 2019. When do you think you might get a better view as to what the plan for the carmakers would be?

Mark, it's Michael Wilson. I think the answer to that question is we don't really know to be perfectly honest about it. We believe that they are certainly on track to meet the 60% adoption requirement for 2018 model year vehicles. As it relates to getting from 60% to 80% by 2020, it's really something that is difficult to predict because there's a lot of moving pieces to this. But the sort of performance to date is any indication, I would say their tendency is to run ahead and certainly not lag the adoption curve.

Okay. And then lastly, where is the progress in Performance Chemicals occurring at I think even a better speed than you were originally anticipating. I assume though that doesn't change the 18% to 20% target range or is there reasons to believe that can be higher or is it that the performance you're seeing can raise the bars that more it's beating it up?

I'm going to leave it. I'm very optimistic about the direction of our Performance Chemicals business. And again I think we clearly see the 18% to 20% in the 2019 timeframe. Let us achieve that then I'll come back and tell you how much higher and guide it.

Fair enough. Thank you. Operator The next question will come from the line of Jim Sheehan from SunTrust. Please go ahead.

Thanks. Question on your plant spending for the Zhuhai, China plant, what kind of impact did that have on your EBITDA in the quarter and also do you see that those impacts continuing in the second half or are those moderating as you as you run the plant harder?

I'm not sure we're so granular to talk about the additional cost from the ramp up. What I would say, Jim, is that if you think back to what we talked about in 2016, the Zhuhai plant was sort of a drag on earnings. So in other words, it had operating losses for the full year in 2016. We talked about at the beginning of this year that we thought the plant would be a more or less at breakeven rate. I would say right now my expectation for the full year is that it's actually going to be breakeven to accretive to our earnings by sort of single digit, millions of dollars.

Great. And in Performance Materials, SG&A costs were slightly higher, is that a transitory thing for the quarter or should we expect that to continue in the second half?

Yeah. So let me just acknowledge two points here. I mean, first of all, we have a fairly simplistic mechanism for allocating SG&A cost. We do that as a percentage of sales to our business. So we may look at doing something different in the future, but that's how we've done it. As you know we push all corporate costs to the businesses. So as Performance Materials over the last couple of years has grown at a much faster pace than Performance Chemicals which actually have seen a decline in revenues from its peak in 2014. Performance Materials is picking up a proportional increase in the share of our total SG&A cost. So keep that in mind. In terms of the overall SG&A costs being up, part of it is the annual evasion of having full stand up costs in the company. The other part that I will acknowledge is variable compensation due to performance of the company we expect that our incentive plans will have higher payouts in 2017 than in 2016 and that's driving a portion of the SG A.

Great. And you're generating a lot of cash right now that's probably going to continue with your net debt to EBITDA now looking like it's 1.5 times in 2017. It seems like you've got a high class problem here you're under levered. Can you talk a little bit about your priorities for uses of cash going forward?

Absolutely, you're exactly right. The outlook is to be about 1.5 times net debt to EBITDA. And we've talked about the fact historically that we're comfortable operating in a 2 to 2.5 times leverage position as a sort of ongoing basis. So it is a high class problem. In terms of capital allocation priorities, again our priorities are one, to fully reinvest in our existing businesses particular Performance Materials business to be sure that we fully support the organic growth that we see in that business. And you are seeing us put capital into that business both in our purification solutions joint venture that makes the honeycomb scrubbers and also with the Changshu investment and there will be others. Performance Chemical which again I think is showing a very positive turn around really does not require a lot of capital going forward. We are still operating assets at well below capacity, so we can support additional growth there. So that's our first priority. Our second priority as we talked about is that part of our strategic plan is inorganic growth and accusative growth. We have talked about the fact that beginning - we started this year, we put the capability and processes in place to begin screening opportunities looking for value creating opportunities for shareholders. We've in fact bid on a number of properties during the first half of this year, but we had to be unsuccessful and that going to speculate as to when we will be, but we are confident there are good opportunities out there. We are going to find value creating ways to invest the cash that we have. If we can't we will find a tax efficient way to return that capital to shareholders. I know that we have as we indicated in our last call a $100 million share buyback authorization. We have used very little of that. We have been consistent that we bought back enough shares to offset dilution from incentive compensation, but we really haven't done much else to that. But I can assure you we are going to deploy that capital in a way that has high returns or we will address the under leverage situation that we have going forward.

And our next question comes from Curtis Siegmeyer, KeyBanc Capital. You are welcome, please go ahead.

Hey, good morning guys. Just a couple of quick ones, one on the guidance, is the bulk of the increase due to the chemical segment coming in better than expected or is part of what you are seeing in materials also baked into that?

I think in system with our prepared remarks, I think the Performance Materials business is basically delivering to the expectations that we had at the beginning of the year and much of the upside fairly is with Chemicals, it's already there.

Is that a combination of both better end markets as well as the raw material benefits that you are seeing or is that kind of more on the raw material side?

I think it a benefit of a number of things. I mean first of all it is the benefit of the cost structure that we put in place over the last 12 months or so. As we restructure the Performance Chemical segment, I think part of that is raw material cost particularly CTOs we talked about and third piece is improving supply demand dynamics in the fine chemical segment. So it's a combination of all those things and I think going forward it also gets augmented by continued innovation, continued reformulation of products to provide solutions for our customers to create value for them and to capture more of that value for ourselves.

Great. And then just a follow up on Materials, the top line has been really strong year-to-date and it's pretty impressive given you know the auto market is looking like production will be down modestly this year and you guys have talked about your ability to grow even in a flat may be down slightly market in the past. So, how far would production have to fall before it may be more challenging for you guys to be able to grow with adoption rates where they are?

I think we are going to have strong top line growth in this business regardless, I can't see this sour rate or the sales rate following to a level that were not delivering strong growth. Clearly it has a marginal impact and kind of as it falls the impact would get greater, but the regulatory adoption is so much more of a strong driver that we are going to see strong revenue growth and our second half forecast I believe reflects that.

Great, that's helpful. Thank you.

And Mr. Sheehan, we are open to back up if you were cut off. Please go ahead.

I have no further questions. Thank you.

Thank you. And Daniel Rizzo with Jeffrey, you are open.

Hi, guys, with the new - exclusion funding the expansion. Do you have enough capacity to meet the anticipated Chinese demand increase in 2020 or is another way of expansion is going to be necessary?

Hi, Dan. This is Michael Wilson, so as I indicated in the prepared remarks, I mean who we obviously look closely at capacity and the sort of coming wave of demand we are going to see in China. We think we are making the necessary investments to fully realize the growth potential associated with that and meet demand. I did indicate in the comments that we expect that we will probably need to add carbon activation capacity. So this is the kind of capacity that we have and we look coming to it in July, probably sometime in the 2019, 2020 timeframe. Part of that depends on whether other provinces in China decide to accelerate ahead of the national mandate. But again we would mention that, that investment is not likely to be of the magnitude of the green field plant we did in Zhuhai which was more than a $100 million, but it is likely to be something that's 50 to 60% of that investment and would be an existing facility and we have sort of called out at this point [indiscernible].

Given then, it's a brown field and not a green field what's the - I mean, how long to they take kind of getting ramped up, is just a few months?

We will be planning that, we are already looking into the options, researching the options, doing preliminary engineering. So not exactly sure when we will pull the AFE forward for that, but the construction period for something like that probably 18 months.

Okay. And then you indicated that - what whether that's kind of slow start in pavements. I was wondering if that basically dependant [ph] of demand of or just kind of - you just kind of lost that instrument to move forward with stronger demand as anticipated, but because it started with it, that's kind of gone.

No. I think we are going to see a stronger third quarter as result of the slow start in the second quarter. So I would look for that business on the full year basis remains intact. As I said we really saw the order patterns shift beginning in June and our outlook in the third quarter is off to a great start.

Thank you very much.

And our next question comes from the line of Chris Kapsch with Aegis Capital. Please go ahead.

Yeah, good morning guys. A follow up on the discussion around Performance Chemicals and the raw material cost. You mentioned CTO, cost benefited the quarter a little bit, I was just wondering if you could quantify maybe in basis points the benefits of the margin. And the reason I am asking is obviously the majority supplier, I believe the contractual step change in costs from your biggest supplier happened on July 1. And so it's sort of thought the other supplier were kind of either simultaneously or lagged sort of link to that contract maybe not leading. So was - is the market for the CTO generally oversupplied versus a down draft in spot pricing that benefited ahead of that contractual reset, if you could just talk about the dynamics there would be helpful?

Sure, Chris. I don't want to guess so granular as I try to quantify the savings our margin improvement for CTO alone, but I do want to clarify the situation in CTO. I think we have talked about on numerous occasions that our largest supplier was from our parent company that we received the ten year supply agreement as part of the spin of the company. That is the market based contract for the supply of CTO, but it did have fixed pricing in it for the first year. The fixed pricing really expired at June 30. So now the pricing for the majority supply which is going to come lesser will begin to reset to more of market levels, but the way that contract works is that the pricing resets on a quarterly basis, but there's about a one quarter lag. So, and the way the pricing works is that there is a market basket of prices that we have from our other suppliers and weighted average of that market basket becomes a proxy for market price. So what you shouldn't expect is sort of a step change cliff function of reduction in CTO from Q2 to Q3. There is a lot complexity and the way our contracts worked among various suppliers and there's a dozen or more paper mills that are part of that supply. Some of those contracts are actually inter-related to one another. They can become someone of a circular calculation. So what I can tell you is that CTO prices have been a benefit to the first half of the year. We expect that they will continue to be a tail wind and at this point, I really see falling CTO prices are tail wind for at least the next six to seven quarters. And I can say that with confidence because we already have locked in those agreements and purchases through 2018. So you shouldn't think about this as a step function, you should sort of think about this as a slowdown road spiral the CTO, that's is going to be a tail win for us gradually over the next few quarters. Does that help?

Yeah, that's helpful. I mean, so the benefit in the quarter was from obviously the non WestRock suppliers and it sounds like - I'll call it a virtual cycle here over the next year and a half. And the other question I had on the PC side was around TOFA and the tightness in the market that are obviously benefitting from the increased derivatization of TOFA and the oilfield demand. Just wondering now, the rest of the TOFA customers in the end markets, are they on allocation I mean a team like TOFA's tight and I am asking because - also curious about how much of the price increase that was announced as gotten through and is it so tight that it might be set up for - it sounds like another price increase and just wondering what your thoughts are around that.

That's a great question Chris. I'm going to let Mike Smith handle that one for you.

Yeah. Thanks, Chris. We actually have been looking at the allocation of customer for TOFA. Clearly moving them to the higher value applications, you mentioned derivatized products which are primary focus to make sure that we grow and support those products. And then a number of TOFA customers frankly that we had overseas that often have other substitute fats that they use have been the types of customers that we have no longer continued to service and so therefore, have a very positive mix from that stand point. And yes, we have had a very good success today in the execution implementation of our TOFA price increase.

Okay, and so there is no reason to think even with some - even with the rig count look even if it's flat and down, even if there is more efficiencies in production from those deployed rigs. It doesn't sound like there is any reason to suspect that the tightness would change certainly through the balance of calendar '17. Is that fair?

Yeah, that's correct.

Okay, and then just one follow up on Performance Materials, I think you mentioned that utilization in your existing China plant benefited results little bit and presumably that means more demand. I am just wondering if the demand pick up that you saw there was related more to the domestic market and adoption of the EVOP standards in China or you also seeing more opportunities to export from that product.

Yeah, Chris its two things, one is we do have qualified customers that we are exporting to, that we are selling product out of that facility to, multinational OEMs, but the other part of it quite frankly is that we are using this opportunity to build inventory in that facility in that business in anticipation of what we know is coming.

As you said the unit costs were better on the inventory built.

Yes.

Sure. And then starting the extrusion plant that you are building, can you just talk about the timeline and then where are you going to be supplying that activated carbon from. Is there a knock on benefit presumably from better plant loading from where we are supplying the carbon? Thanks.

Yeah, I'm going to let - I'm going to let Ed Woodcock to answer that for you.

Yeah, Chris, good question actually. The timing on flat first is construction is underway. We expected it to be up and operational by the end of 2018. The product that we will be extruding is currently what we sell into the process, the purification market. So that powder carbon, we will be having a nice mix upgrade by shifting it from the lower value process purification application into an automotive product and begin selling it at a much better value proposition for us.

So, right. So more of a mix benefit than a manufacturing utilization benefit, but benefit none the less. Sounds like good. Thank you for the color.

And next we have Ian Zaffino with Oppenheimer. Please go ahead, you are open.

Good morning guys. This is Mark on for Ian. Thanks for my question. I just want to get your gauge on the industrial specialties demand in Performance Chemicals. Just wondering when we can expect an improvement in the space and what you guys are seeing in terms of current drivers of weakness and your colors or rebound. Thank you.

Yeah, I think what we are seeing in industrial specialties is a lessening of the pressure across those applications in aggregate, I mean fairly oilfields as we talked about as seen a significant rebound with a 35% revenue growth in this quarter versus the same quarter last year. Pavement we're going to continue to see solid growth in that business and margin improvement because of lower costs. But when you look at the segment as a whole, I mean if you look at the pricing impacts that we had in that business in Q1 and you compare the same in Q2, you can see that some of the pricing pressure has begun abiding. So we talk about two value streams there, the TOFA stream and the rosin ester - the rosin stream and TOFA is experiencing really demand as supply, but the rosin market remains soft mostly because of lifetime fine chemicals competition, but also because of other substitutes. We're not through the point there yet where we're seeing a significant growth nor we're pointing where the supply demand is where we have a lot of pricing leverage, but we've certainly seen a bottling [ph]of the pricing pressure in that segment. So I think it's set up well as we go forward. We're just clearly being cautious about the recovery at this point.

Okay, guys. That's very helpful. And then if you don't mind, I guess a quick one on your sensors. I guess expectations for TOFA for the balance of 2017 and then if you could give any sense of the expected tonnage or the capacity on your end. Thank you.

We don't really talk in terms of tonnage. We talk more in terms of revenues being a specialty business. But again, we clearly laid the expectation that we think the dynamics are such that demand is going to remain strong for those TOFA based products for the balance of the year.

Okay, got it. Thank you very much.

[Operator Instructions] And speakers no one else has queued up. Please continue with any further remarks.

Thank you, Art. I want to thank everyone for your time and interest this morning. Obviously, we remain very positive about the long-term outlook for our business and we look forward to talking with you again next quarter. Take care.

Ladies and gentlemen, that does conclude your conference for today. Thank for your participation. You may now disconnect.