Ingevity Corporation (NGVT) Q1 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Ingevity First Quarter Earnings Conference Call. [Operator Instructions] As a reminder, today’s conference call is being recorded. And at this time, I’ll turn the conference over to our first speaker, Vice President of Investor Relations, Dan Gallagher. Please go ahead.

Thank you, Nick. Good morning, everyone. Welcome to Ingevity’s First Quarter 2018 Earnings Conference Call. Earlier this morning, we posted a presentation under the Investor section of our website. If you haven’t already done so, I would encourage you to download this file so you can follow along on today’s 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 the call or to update them to reflect events or circumstances occurring after the date of this call. 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 and can be found on the Investor Relations section of our website. Our agenda is on Slide Number 3. With me today, as always, 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 review the performance of our two segments. John will discuss our current financial status and our revised guidance, then Mike will make some brief closing remarks before we open the line for Q&A. Mike Smith, President of Performance Chemicals; and Ed Woodcock, President of Performance Materials, will join the call for the Q&A. And with that, I’ll turn it over to Michael.

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’ll note some highlights for the quarter. All in all, we had a great start to the year that was in line with our expectations. Recruit market dynamics and product demand, strong execution and the continued benefits of our disciplined cost structure enabled us to post a 34% jump in adjusted EBITDA on high single-digit revenue growth in the first quarter. Overall, our performance was excellent. Revenues in the first quarter were about 8% higher when compared to the previous year’s quarter. Volume, price and product mix all contributed to the increase. Volume growth resulted primarily from sales of Performance Materials segment’s activated carbon products to the global automotive market. In addition, sales in Performance Chemicals benefited from higher sales to the oil services and pavement industries as well as the company’s recent acquisition of Georgia-Pacific’s pine chemicals business. These revenue increases were partially offset by declines in sales to industrial specialties applications as we shifted available product to higher value-added oilfield and pavement technologies applications. We delivered adjusted EBITDA of $67 million, which was up $17 million versus the prior year’s quarter and reflecting nearly 34% increase. In addition to the revenue impacts, our earnings were aided by lower raw material costs, specifically for crude tall oil, or CTO, and favorable foreign exchange impacts. These positives were partially offset by higher production-related costs, including freight. Our first quarter adjusted EBITDA margin of 28.5% was up 550 basis points from the prior year quarter margin of 23%. As you can see on Slide Number 5, our Performance Chemicals segment continued its improved performance, based on the shift to higher value-added products. Segment sales in the first quarter were $140 million, up almost 3.5% versus the prior year. Sales in Performance Chemicals products to oilfield customers were up about 22%, as U.S. drilling activity continued to increase. The U.S. rig count, according to Baker Hughes, climbed to 993 in the first quarter, up from 929 in the last 3 months of 2017 and 824 in the first quarter of 2017. As important, oil drilling rigs continue to gain efficiency. As the linear feet drilled by each rig increases, it has an additional positive impact on demand for our products. Anecdotally, the rig count broke 1,000 in the U.S. during the first week of April. As a reminder, sales of pavement applications are typically light in this quarter. Most of our revenues in pavement technologies, approximately 75%, are generated in the second and third quarters in connection with the primary paving season in North America. That said, sales increased by about 9% versus the previous year’s quarter as we were able to drive adoption of our products in new overseas markets. Revenues in North America were in line with our expectations. However, we experienced an increase of about 50% in regions outside of North America, albeit from a small base. We saw growth in South America, particularly Brazil and Peru, and in Australia and South Korea. We continue to focus on expanding our footprint in this business globally. Sales into industrial specialties applications and these include printing inks, adhesives, agricultural chemicals, lubricants and others were down 1% versus the prior year period. As previously discussed, we run our biorefineries based on rosin-demand dynamics, which in turn determines the availability of tall oil fatty acids or TOFA. In the quarter, demand for and prices of rosin-based products remained stable as they did through last year. As TOFA supply was constrained in the quarter, we continued to shift production to TOFA derivatives to meet the demand of more profitable applications such as oilfield services and pavement technologies. This, combined with our success in recovering TOFA prices, had a significant positive impact on overall segment margins. Performance Chemicals segment EBITDA of $25 million was up about 59%. This was the result of improved price/mix benefits, lower costs for crude tall oil and our acquisition of Georgia-Pacific’s pine chemicals business. This drove an improvement in EBITDA margins of 620 basis points. On March 8, we closed the G-P pine chemicals acquisition, and in only three weeks, it had a meaningful impact on our results. Our teams are highly engaged in bringing across its Arkansas facility into our network, and we’re already seeing the benefits of shifting production to the most efficient location by product. We’re continuing to focus on swiftly integrating the business and delivering the synergies we outlined when we announced the transaction. In the quarter, the acquisition contributed about $5 million in sales and $2 million in segment EBITDA, which was consistent with our expectations. Based on our experience to date with this business, we fully expect the acquisition will live up to, if not exceed our longer-term expectations. As you can see on Slide Number 6, our Performance Material segment once again turned in a strong performance. Segment sales in the first quarter were $96 million, up nearly 15% versus the prior year’s quarter. Revenues rose primarily on the strength of sales due to the implementation of increasingly stringent regulations for automotive gasoline vapor missions, mostly in the U.S. and Canada. Consequently, we realized a sharp increase in sales of our honeycomb solutions used by the automotive industry to comply with the U.S. Environmental Protection Agency Tier 3 and California LEV 3 standards. Overall, revenue growth of this segment was only marginally impacted by North American automakers' reduced production of 3.3% versus the prior year’s quarter. Of note, U.S. auto sales in the quarter were up 2.1% versus the prior year, which was an all-time record for first quarter vehicle sales. In addition, the move toward trucks and SUVs in the U.S. is continuing. According to Ward’s, the split between cars and trucks moved to 32% cars and 68% trucks in the first quarter from 37% and 63% in the previous year. This is indicative of a long-term trend. For example, you may have noticed Ford’s recent announcement regarding their shift in their portfolio away from sedans. By 2020, Ford says 90% of its portfolio in North America will be SUVs, trucks and commercial vehicles. As a general rule, larger vehicles have a positive impact on demand for our products. Performance Materials adjusted EBITDA of $42 million was up 22% versus the prior year’s quarter. This translated to a 44.2% adjusted EBITDA margin, which is up 280 basis points from a year ago. The results were driven by volumes, primarily for honeycomb products, and improved pricing for pelleted products. The gains were partially offset by increased spending to support our growth and higher logistics and energy costs. Last week, as you may know, the China 6 national standard was promulgated at the end of 2016 and all vehicles must be in full compliance by July 1, 2020. Several regions and municipalities are now expected to adopt earlier. At the end of last year, the Hebei Province confirmed a January 1, 2019, early adoption date. Last week, the public hearing period for Shenzhen City ended in the region, which consumes approximately 400,000 vehicles a year, announced their intent to implement the new standard on January 1, 2019. In addition, Hainan Province, which consumes approximately 160,000 vehicles a year, publicly announced they were evaluating early adoption. Overall, these three regions represent annual sales of approximately 2 million vehicles. We believe that this trend of early implementation could continue. Our Performance Materials team is actively preparing for this increased demand, and this will remain a key area of focus for us this year. At this point, I’m going 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 our updated guidance for 2018. John?

Thank you, Michael. Good morning, everyone. I will provide some additional color on the results, review our capital structure and discuss our outlook and guidance before turning the call back to Michael for some closing remarks. As Michael said, the first quarter was a great start to the year and was in line with our expectations. We are pleased with the revenue performance and margin accretion in both segments. Moving down the income statement, net interest expense for the quarter was $6.1 million, reflecting the increased expense associated with our senior unsecured bond that was issued in January. Our borrowing rate at the end of the quarter for our bank term loan was 3.13%. The rate on our senior notes is fixed at 4.5%, and the $80 million dollar industrial revenue bond borrowing rate remains at 6.67%. Our provision for income taxes on adjusted earnings was $10.8 million for the quarter. Our adjusted tax rate as of March 31 was 21.8%, down from 32% a year ago. Our net income attributable to non-controlling interest, which is the impact of removing from our results the 30% of the Waynesboro joint venture that we do not own was $5 million in the quarter. During the quarter, we repurchased 41,300 shares at a weighted cost per share of $75.01. $90.3 million remain available from our board-authorized share repurchase program. Diluted adjusted earnings per share in the quarter was $0.79, which is a 16.2% increase from the first quarter of last year. As of March 31, Ingevity had 42.1 million basic shares outstanding and 42.6 million diluted shares outstanding. Turning to Slide 8, our net debt at the end of the quarter was $628.7 million. This reflects the funding of the Georgia-Pacific pine chemicals acquisition as well as our seasonal working capital build in advance of the pavement season. However, our net debt to EBITDA was 2.4 times at the end of the quarter, within our stated long-term desired leverage target of 2 times to 2.5 times. Working capital did increase significantly in this quarter due to three things: first, the buildup of inventory in advance of the pavement season; second, the inclusion of Georgia-Pacific’s product inventory; and finally, the intentional buildup of activated carbon inventory in preparation for the adoption of China of that country’s new gasoline emissions standards. Additionally, our accounts receivable and accounts payable both increased as we absorbed the balances from Georgia-Pacific and as our sales in the first quarter ramped up, particularly in the last month of the quarter, as we began the pavement selling season. As we discussed in our Investor Day, we are continuing to build inventory of activated carbon in advance of Chinese regulatory requirements and subsequent product demand. We need to do this in order to ensure available supply given the uncertainty in timing and rate of adoption. This will be a multiyear process as we must ensure we have the carbon required to meet the country’s requirements. As Michael mentioned, the situation is dynamic and the potential for early adoption is real. As soon as the adoption curve becomes clear and demand trends stabilize, we will work this inventory back down to more normalized levels. Our cash from operations in the quarter was $9.7 million, and capital expenditures were $13.3 million. The resulting free cash flow was a slightly negative $3.6 million. This number is an improvement from last year. As a reminder, due to the seasonality of our businesses, we typically turn cash flow positive in the second quarter. Additional information will be available in our Form 10-Q, which we expect to file later today. As Michael said earlier, we have improved line of sight to our 2018 outlook, both its opportunities and risks. In the Performance Chemicals segment, we anticipate our high-margin application areas to continue to show strength. Across the segment, we are working to recover pricing for both tall oil rosin, or TOR, and TOFA-based products. While we have already seen improved pricing in TOFA and derivatives, it’s too early in the process to be clear on the full benefits of our efforts in TOR-based products. While the Georgia-Pacific pine chemicals acquisition contribution so far is in line with our expectations, we are working to accelerate synergies this year, and we expect continued tailwinds related to CTO costs. Like many manufacturers, we are expecting some modest inflationary pressures primarily related to freight logistics and energy. It is a primary objective for both segments to grow volumes, improve product mix and recover prices more than sufficient to offset these increases. We still expect the segment to deliver strong double-digit EBITDA growth. In fact, even without the benefit of the G-P pine chemicals acquisition, Performance Chemicals will deliver double-digit EBITDA growth. When thinking about the Performance Materials segment, we’re also still targeting strong growth. However, it’s important to recognize that the quarterly year-over-year growth in sales of honeycomb products is expected to slow each quarter throughout the year. Automakers are not obligated to increase Tier 3 compliance until the 2020 model year. While we posted 14% sales growth in this quarter, we anticipate the full year growth rate to be high single digits, approaching double-digits for the segment. Likewise, as we have discussed, you must look at the margins on this business on an annual basis as there are quarterly distortions due to production rates by OEMs and outage schedules. While margins in this segment may move up or down each quarter, we do believe the annual EBITDA margin for the segment will accrete over 2017. As we discussed on our last call and at the Investor Day, first half growth will be stronger in this segment than the second half of the year due to the Tier 3 adoption schedule. For modeling purposes, the $5 million in R&D interest number we earned this quarter is probably a good guide for each of the remaining three quarters. National adoption in China is not required to begin until July 2020. However, as mentioned, we may potentially benefit from activated carbon demand in China based on early adoption by some municipalities regions. Also, we will be impacted in the second half of the year by two significant planned outages at both Covington and Wickliffe. We are also, as said before, encountering some inflationary cost pressures which we are committed to working to offset. Nonetheless, we expect double-digit growth on our Performance Materials segment. In light of all this, if you turn to Slide 10. We are narrowing the range and raising the midpoint for our guidance on both revenue and EBITDA for the year. We are raising the midpoint, tightening our fiscal year 2018 guidance of sales, to between $1.1 billion and $1.13 billion. We are raising and tightening our adjusted EBITDA guidance to between $293 million and $307 million. Our adjusted effective tax rate this quarter was 21.8%. However, we continue to believe we will realize a range in the 22% to 24% range for the full year. We expect our cash tax rate for the year to be around 17%. There are still a lot of uncertainties in the tax law changes, and we have some exposure to our foreign entities positions as we work to restructure and optimize our tax position overseas. With regard to capital expenditures, our spending each year is back-end loaded. So while we spent $13.3 million this quarter, we still intend to execute our full plan for the year of $89 million. We do, however, believe we will generate higher free cash flow for the year despite the higher capital expenditures. This is due to higher operating profit and a better tax position. Accordingly, we are adjusting our free cash flow forecast to between $100 million and $110 million. Our net debt to EBITDA ratio at year-end, based on current capital allocation plans should be less than two times. I will now turn the call over to Michael.

Thanks, John. In summary, as we kick off 2018, we’re optimistic it’ll be another strong year of performance for Ingevity. Our focus is on efficiently integrating the G-P pine chemicals acquisition, capturing the benefits of improving market conditions in Performance Chemicals, preparing for growing global demand in Performance Materials and turning in another strong performance in 2018. I appreciate the work and efforts of our 1,600 employees worldwide. They are a distinct competitive advantage for us. We continue to believe very strongly in the long-term potential of our company. We hope you share our enthusiasm for Ingevity. At this point, operator, we’ll open up the call to questions.

Thank you. [Operator Instructions] We’ll go first to the line of Mark Weintraub with Buckingham Research. Please go ahead.

Thank you. A couple of questions. First off, on your guidance, does that incorporate a significant amount of benefit from the price increases in the tall oil fatty acids and the rosins, et cetera, the 10% to 20% increase you had announced would be effective May 1? And or how does it handle the potential for the early adoption in China?

Hey, Good morning Mark. This is Michael Wilson. Yes, our guidance does include all of our assumptions around pricing, volume and other impacts as we go throughout the year. As you indicated, the price increases that we announced on the TOFA and TOR products wasn’t effective until May 1. So it’s a little bit early yet to call exactly how that’s going to play out. But of course, we’ve made some assumptions about our ability to gain traction on that in our outlook, and it’s embedded in there. In terms of the early adoption in China and the provinces who decided to go early, there’s still a little bit of uncertainty for us in timing. We’re – I think we’re being appropriately cautious and conservative in the outlook. We’re expecting that there will be some benefit into the fourth quarter, which is embedded in our guidance, but it’s really difficult at this point in time to know just how soon or how fast that additional demand’s going to come.

Okay. And just one quick follow-up. On – with higher oil prices, can you speak a little bit to potential implications that oil prices stay at the types of levels where they are today?

I think, in general, higher oil prices at the levels they’re at today are favorable to our business and market dynamics in our business. At the same time, where they’re at today is not going to impact the tailwind and benefits we’re seeing on the CTO side. So I think largely right now, we’re in an environment that’s a win-win for Ingevity.

Thank you, very much.

Our next question comes from the line of Ian Zaffino with Oppenheimer.

Hi, come on guys. This is Mark Zhang on for Ian. Thanks for taking my questions. I just wanted to dig a little bit into Chemicals a little bit. So in regards to the margin profile this quarter, of the margin improvement, how much was it related to better mix from industrial specialties?

Well, I’m not getting specific to individual specialties, but I would say that improved mix had a significant impact on the segment overall – or on yes, on Performance Chemicals overall. And again, it’s largely because we’ve sort of rededicated or redirected product to its most profitable end uses. So industrial specialties, in fact, saw declines in volume available because we redirected those products to pavement technologies and oilfield applications which are higher margin. So I think that mix shift is part of the benefit to the segment. In addition to that, the fact that we’ve gone from selling more direct TOFA to selling derivatives may be even a bigger portion of the benefit. But that’s kind of part and parcel to selling into these other applications.

Okay, got you. And I guess like selling to these other applications, sort of like in terms of – at what stage are you guys currently in, and what potential there is going forward. Maybe just like a general sense if you can’t go into detail.

Look, we expect we’re going to see continued robust growth in both our pavement business and in our oilfield business, so those are developing very nicely for us. I would think on the industrial specialty side, we’re also now more cautiously optimistic of seeing improvement there. As we indicated in our prepared remarks, we’ve really seen stability both in volumes and pricing over, say, the last 12 months or so for rosin-based products. And we’re a little bit more optimistic about those going forward, both in terms of demand and price. However, again, we’re being pretty cautious on the price piece because it’s a little early in the process.

Okay, great. Thank you, very much.

Our next question comes from Jon Tanwanteng from CJS Securities.

Good morning ,gentlemen very nice quarter. If I could start, you had a relatively great quarter from an earnings standpoint, but the guidance was only raised maybe about $5 million to the midpoint. Is that a signal that there could be some deceleration ahead or inflationary headwinds? Or are you just leaving yourself room?

Hi Jon, this is Michael Wilson. Well, I just think it’s pretty early in the year. Clearly, we have a better line of sight on 2018 than we did three months ago, but there’s still a lot of moving dynamics, things like our ability to secure pricing on the Performance Chemical side, understanding exactly what will happen with automakers around Tier 3 LEV adoption in the second half of the year. Again, as was pointed out, there is no mandate for them to increase that. So we’re taking a conservative view that they do not. And then, of course, I think also as John mentioned, outages are also important to us, and we are sort of second-half loaded in terms of outages with a significant one at our Covington facility. We’re replacing a kiln that – it’s something we don’t do but about every 20 years. We have a couple of those we have to replace over the next 12 months or so. So I think the short answer to your question is we feel confident in the guidance that we’re giving you. I think it’s going to be a strong year, but we’re trying not to get ahead of ourselves.

Got it. That’s very helpful. And John, just a quick question on G-P, how much did it actually contribute in the quarter in terms of revenue and earnings?

Yes, we talked about it, right? It was about $5 million of revenue and about $2 million of EBITDA.

Perfect. Thank you. And then just on the Chinese provinces that are still deciding or talking about moving the date ahead, do you know which ones specifically are in the discussion and kind of how many cars that represents that actually could still go?

Yes, I think we have some information on that. I’m going to allow Ed Woodstock to comment.

Good morning, Jon. There are a couple. Hainan, which is a small island off of Guangzhou province. It’s about 160,000 vehicles. Shenzhen City as well, in discussions on a January 1, 2019 implementation. They’re about 400,000 vehicles. And then Hebei, which surrounds Beijing, about 1.6 million vehicles so far and that’s a little over 2 million vehicles that have announced early adoption for January 1.

Right. And the potential ones that haven’t announced yet but are actually discussing it?

Yes, it’s kind of more in the Pearl River Delta, and then additional around Shanghai is also in the mix as far as discussing it, but likely not an early 2019 adoption but maybe mid-year of 2019.

Okay, great. And the number of cars in those two regions per year, if you have that information?

Yes, probably the delta totals about 2.2 million, and that includes Shenzhen and Guangzhou, and then the Yangtze River Delta, the Shanghai area is about 5 million vehicles.

Great. Thank you very much for the color.

Our next question is from Jim Sheehan with SunTrust. Please go ahead.

Thank you. So on your Performance Chemicals margins, it came in a little better than expected this quarter. Can you talk about the timing of getting back to your normalized levels of 20%-plus? And with synergies possibly being accelerated from Georgia-Pacific and with – clearly, the oil price in the mid-60s is much higher than your assumed range of only about $50.

Hi, good morning, Jim, this is Michael Wilson, and thanks for the question. Prior to the G-P acquisition, I think we were solidly on track to do exactly what we said we were going to do, which was to drive margins 18% to 20%. I think as you’ve talked about, the current market dynamics are favoring that and helping that. Of course, now having G-P as part of our business is also helpful. Without getting too specific on that, I mean, I think by the time we get to the full year 2018 margin’s in that business are going to be roughly 20% plus or minus something. So...

Great. And then in terms of China and the early adoptions that you’re seeing and the potential early adoptions, I’m just curious about what you see is a bigger risk to your business in activated carbon there. Would it be early adoption causing you to have to hurry up and produce more, or possible delays to emission standards in China causing you to need to slow it down?

Well, we’re preparing hard for early adoption. Again, we’re not calling for it, but we know that we have to be ready because of the market position that we have. So we talk about it a great deal and neither John nor I are very happy about our working capital statistics and the inventory that we’ve built, but it is intentional and it is strategic because we can’t afford not to be an unfailing supplier to our customers. So we’re ready for it if it comes, and we’ll be sure that we’re able to supply. But the other side of your question is the risk of delay. I mean, I think, first of all, I see that as a low risk. But if it is delayed, it probably just means that we carry working capital for a bit longer than we would like to. But we’re confident that China is on this path to adoption and to implement the regulations that they’ve passed.

Great. And on your process purification revenues, how do you expect that to – those to trend over the next 1 to 2 years? Do you expect those to decline as China ramps up in automotive?

Yes, I think they undoubtedly will decline, as China ramps up and we redirect product to more profitable applications. But Ed, is there anything specific you want to add to that?

No, as we previously discussed that, we’re basically taking that powdered carbon that we sell into those markets and going to be moving it to the automotive market where there’s a nice mix upgrade from that move.

Thank you.

Our next question will come from Michael Sison from KeyBanc Capital. Please go ahead.

Okay guys. Nice start to the year.

Thanks Mike.

One quick follow-up on China. Your market shares are pretty good there, but lower than the rest of the world. Given some of the early adoptions, are you better positioned in these areas that have adopted? And is there a couple more – if the ones that you talked about do as well adopt, would your market share go up quite a bit?

Yes, Mike. This is Michael. We’ve been pretty consistent in saying that – you’re correct. And if you look at our market share regionally in the automotive application, it’s lower than China than it is in other regions. And it’s been that way because the regulatory bar, the standard, from a technical standpoint, has been low. That technical bar for performance is being significantly raised, along with the more stringent regulations. We believe that certainly plays to our advantage. And it’s our expectation that as China adopts, we’ll not only benefit from the additional volume, but from increased share as well.

Right, okay. Great. And then, in Performance Chemicals, I think you set the initial goal to get to a segment EBITDA margin of 20%. You’re pretty close there. Sounds like demand, oil prices, a lot of things are going in your favor. How quickly do you think you can get there on an annualized basis now based on what you see? And is there upside to that longer term?

Mike, are you talking about how quickly we can get to the 20% threshold, EBITDA margin?

Yes, EBITDA margin.

Yes. As I had mentioned a few minutes ago, I think in 2018, we will achieve that plus or minus 0.5% or something. So I think we’re going to get there. I think that the bigger question is how quickly we can drive margins above 20%. As you remember at our Investor Day in February, we said over the sort of planning horizon we have for the business, we think we can drive margin in that business into the mid-20s. Now that will happen over time and gradually, but there’s a lot of potential upside in chemicals.

Okay. And then just a quick follow up on the turnaround or outages that you need to incur in the second half of your Performance Materials. I apologize if I missed it. Did you quantify the impact, and will that sort of come back in 2019 as kind of a plus?

No, we did not we did not quantify it, and I’d really prefer to wait maybe till the half year to sort of give you that sense for what it means first half versus second half. But it is a relatively significant outage and it’s fairly complex, so tremendous amount of planning going on for that. So we have 2 more kilns that we have to replace at our Covington facility. So one of those will be this fall in 2018, but then, we have another one, which is a similar project that will occur in 2019. And I don’t know – do you know yet whether that’s first half or second half of 2019? A – Ed Woodcock: Second half.

So second half of 2019. So it’ll sort of be the same dynamic in 2018 and 2019.

Got thank you.

Next, we’ll have questions from the line of Daniel Rizzo with Jeffries.

Could you tell us the difference – or how it works with like what the amount of activated carbon used in a truck versus a car, the magnitude in difference?

Yes, it varies. It’s really – the best way to think about it is it’s – if you’re talking about the U.S., it’s proportional to the size of the gasoline tank, right, because the size of the gas tanks really determine the amount of vapor that’s going to be coming off a particular vehicle. So I guess the example we use is if you have a Ford Focus – or I don’t know what the right car is. But if you’ve got a 12-gallon tank versus a Chevy Suburban that’s got a 33-gallon tank, you’re going to see a significant difference in the numbers – or the amount of liters of the pelleted carbon that’s in the canister. And then, of course, it will also make a difference on either the number or size of the honeycomb scrubber that goes with the vehicle. So essentially, the larger the vehicle, the more content we have on the vehicle and on the product. And that’s why we periodically remind you of this shift that’s going on in terms of consumer preference in the U.S. towards, not only larger vehicles, but more SUVs and trucks. But a small vehicle might have 1.8 liters of our pelleted carbon where a Suburban might have 3.5 liters.

] Is it – I mean, is it as simple as like a one – I mean, are there efficiencies that are gained with a larger truck? So just for number’s sake, for a Ford Focus with a 12-gallon tank, it’s $2 worth of activated carbon versus a 36-gallon tank. You just multiply by 3, so it’s $6. Does it work like that? Is it a 1:1 ratio?

No, it’s not quite that simple. So the amount of product is proportional and the carbon, it’s not the same price per unit. But probably, the piece that makes the economics non-proportional are the honeycombs.

Got you. And then you mentioned that your – you built inventory in China in – just in anticipation of demand in activated carbon. Are you anticipating more of a buildup over the next couple quarters? Or are you at a level you think is sufficient to meet what you’re expecting demand at the end of the year in 2019 given the changes in dynamics?

No, I think we will continue to build inventory until China really kicks in in earnest, and then you’ll see that inventory drawn down. I won’t get specific on what the inventory build is, but that assumption is embedded in our cash flow guidance for the year.

Thank you very much.

Next, we have a question from Chris Pash with Loop Capital Markets.

Good morning. It’s Chris Kapsch. So I was struggling with multiple calls, so apologize if you’ve gotten – if you’ve dug into this a little bit. But a couple of follow-ups, one on Performance Chemicals. Did you discuss like order of magnitude? What were the biggest contributor to the year-over-year margin improvement, presumably mix associated with the strong energy end market, mix associated with Georgia-Pacific, pricing and then CTO costs being down year-over-year? Did those – were those equal contributors or is there an order in which one’s much larger than the others?

Yes, Chris, we did address them a bit, and it’s actually in our slides. There’s a bridge that shows the impacts of price mix, costs, et cetera. But let me just allow Mike Smith to just give some color on what he’s seeing in the marketplace overall for Performance Chemicals.

Sure, Chris. Well, first, as we indicated in the script, the contribution from the Georgia-Pacific acquisition is about $2 million in EBITDA. The next largest component of significant magnitude is the increase in oilfield sales, which has been largely of an increase in our higher-margin derivatives. We also had a fairly significant improvement in TOFA pricing. And then the last bit would be the increase in our overseas pavement technology business, while, off of a small base, as you know, that’s a strong margin business for us. And underlying all that, the decrease in CTO costs for – compared to first quarter last year.

So now that you’ve had – I guess you’ve closed Georgia-Pacific not quite 2 months now, I guess, just wondering if you see opportunities now, either with like the – any surprises or opportunities that have presented themselves with the benefit of owning the business for 2 months, with respect to – I don’t know, the customer list or the assets or the logistics that you anticipated would result in some synergies at this juncture? Anything to speak of?

Yes Chris, just a couple of general comments, and then I’ll let Mike give you some details. But we’re very pleased with the acquisition. We got a great organization and a great site out in Crossett. And I’d say – it’s a better business than we thought it was. But Mike?

Yes, just to add to that, I think from an overall business standpoint, revenue, EBITDA, what we bought is very much in line with our expectation, if not somewhat better. I think what is really exciting – our organization and the teams that are working together are the number of synergy opportunities that we have as we sort of get under the hood a little bit further. The opportunities to utilize a 3-plant network more efficiently to combine both the plant operations and the difference that each organization has used from a process technology standpoint and putting those together are really unveiling some opportunities that I think are going to give us some opportunity to accelerate the synergy opportunities over the next couple of years, and hopefully even increase them compared to what we had originally anticipated when we announced the acquisition.

That’s helpful. And if I could just – one follow up on the performance materials side. I think, John, you said for modeling purposes that the equity line would be roughly $5 million a quarter. Is that – I mean should we be thinking of that as a good proxy for the trajectory of the consolidated performance of that overall segment, given that we’re still predominantly depending on the North American market at this juncture?

Well, there’re 2 pieces to it, right? There’re the honeycombs and there’s the carbon, right? So we’re trying to be sort of as transparent as we can be, right? I think by using the $5 million a quarter, that gives you a good sense of where we think the honeycomb business is going. But as we’ve talked about the quarter – or we talked about the segment in its totality, we put up sort of 14% growth on the top line this quarter. We see that number over the course of the year coming down, so that over the whole year – so for the year 2018, the growth of that segment should be in the high single digits, approaching the 10% range, right. So you will see the growth each quarter sequentially coming down, but yet, it will be – for the year, it’ll still be up high single digits for the segment.

Okay. So – but on a sequential basis, it’s – so that is a reasonable proxy, I guess. Obviously, you’re facing tougher comps in the latter half of the year as we don’t get the step-up in penetration rate, right? Okay. Got it.

Just one clarification, I guess, while everybody’s on the phone before we jump to the next question. It’s been brought to my attention that when I talked about industrial revenue bond, I said 6.67%. For those of you who follow it, I hope you know it’s 7.67%, and that’s a fixed cost for us.

Thank you. We’ll take a follow-up question from Jon Tanwanteng from CJS Securities.

Just one quick follow up. I think you mentioned that you were able to get pricing on the carbon pellets portion of your business. Just wondering what drove that. Was that just directly related to input and production costs and you’re passing that through? Or is there some greater pricing power that you have in that business that you can kind of extend to the rest of the business? Any thoughts on that?

Yes, Jon, we did pass through a general price increase on our pelleted carbon. It’s something we’ve done historically on a consistent basis. Maybe not so much over the course of, say, 2016 and 2017, but low single digits on a percentage basis, but across the board. And it will obviously contribute to margins. And again – and we’ve talked about this in our required – our prepared remarks, in that we are sensitive to ongoing inflationary pressures. I think most companies are not experiencing this, it’s something they haven’t seen in 5 to 7 years, but we’re trying to stay ahead of that and stay on top of it. And again, it’s a mandate for both Ed and Mike and their teams to be sure that they’re more than offsetting any inflationary pressures through better price, better mix and volume growth.

Great, thank you very much.

We’ll go now to the line of Mark Weintraub with Buckingham Research.

Two real quick follow-ups. First, just trying to understand, with the adoption in China scheduled for January 2020, should one interpret that basically all cars, starting in the second half of 2019, that are being made in China will have adopted the more stringent technology? Or does it play out a little differently there than it would in the U.S.?

Yes, firstly, Mark, the actual adoption date is July of 2020. So I think you may have said January. Ed, you just want to comment on how you expect that to play from a model-year vehicle standpoint in China?

Yes. And actually, China is unique. It doesn’t do it by model years, it’s by date across all vehicles. So the U.S. is kind of unique in that they allow phase-ins across model-year vehicles. But if you think about Europe’s regulations, it’s changing September 1, 2019, and China’s, it’s changing July 1, 2020. Those will be instantaneous points in time, where from that point forward, all vehicles, 100% of vehicles will have to meet that standard.

And so would that realistically mean – and I don’t frankly even know. Does China do model years the way we do in the U.S.? But would that mean that basically all cars – when is the turnout – the changeover in China? How might that – when would producers meet that? When would OEMs need to be making the transition in their platforms to make sure that any car they were selling in China starting July 2020 would meet the standards?

Yes, Mark, each OEM in China has their own individual strategy about how they going to implement that. That’s typically layered with what provinces decided to move earlier and adopt that implementation sooner. But as model years are – or model-year vehicles are switched over, new ones introduced, they will be most likely switching those to the new standard instead of waiting until July 2020. There are certain parts of the regulation, so you think things on vehicles, it’s not just an evaporative canister regulation, there’re tailpipes, emission standards as well as others. So there’s a possibility that an automobile company will add certain components to a vehicle so that they will eventually get to a full 100% certification. But because there’re so many vehicles and so many platforms, they are going to have to layer this in between early 2019 until the ultimate 100% requirement in July 2020.

So Mark, this is Michael Wilson. I think the best way to think about it is now that some of these provinces and cities have definitively declared that they’re going early, as early as January, so this is going to begin, and we’re – we have to begin seeing some – at least limited demand by the fourth quarter of this year. And then I just think it’s like a ramp that goes up to 100% by July 2020, and I think that that ramp curve or accelerates as you then go forward. So what the exact slope and acceleration is, that’s the clarity that we don’t have. But it’s going to have to happen pretty quickly once it starts.

And just to clarify, so by July 2020, we’re at 100%? So when you say it starts – like the ramp starts accelerating, you’re just saying it’s – just to make sure I understood that. So it starts accelerating as we go to July 2020, not after July 2020. Is that the – what you meant there?

That’s exactly right. By July 2020, per the regulations, per the law, every vehicle sold has to be compliant.

Okay, super. And then lastly, it’s a small one. But can you give us a sense as to what percentage of your out – of your sales in pavement technologies are outside of North America at this point?

I’m not sure what we’ve disclosed, but roughly 20%?

20% to 25%.

Okay, super thank a lot.

Next, we have a question from Davis Paddock with Invesco.

Good morning. Just a quick follow up on China. What is the latest that have given – a car manufacturer can begin to process the transition? Is it, yes, three months out or six months out? Or any thoughts here of what’s the average amount of time it takes to sort of – to ramp that up?

Well, I think from an auto maker’s standpoint – look, they’ve been planning for this regulation for 3 or 4 years now, so they are prepared to begin implementing. They’re just going to do it consistent with the decisions that are being made both nationally and locally. Again, from our perspective, I think by late this year, we should see the beginning of the demand from the regulatory shift. What we’re not completely forecasting, particularly at this point, is what that ramp curve looks like from late 2018 to July 2020. But it’s – China’s what, now, at 25 million vehicles or more?

More.

Yes. So it’s a lot.

Going back to the pine chemicals business, on the Georgia-Pacific acquisition, I believe at the time that you announced the acquisition, you mentioned that they had – I think it was around 30% EBITDA margins. Was that – is that correct? I noticed they did 40% this quarter. Was there anything unusual that drove that higher margin’s performance?

I think the 30% number is a good number.

Why was this quarter 40%?

Go ahead, Mike.

The – in the quarter, the – we had a mix on some of our lower margin biofraction products, where we were sort of accumulating inventory for a larger sale that will take place during this quarter. So within that three-week period that we owned it, the mix was more skewed towards the higher-margin products and did not include some of the lower-margin biofraction products.

Thank you.

But I guess, to be clear, I mean the sort of 30% EBITDA margin for that business is pre-synergies.

Right.

Correct.

And we have a question from Jim Sheehan with SunTrust.

Hi Jim.

Hi, Thank you. So based on your dialogue with auto OEMs that are selling cars in China, would it be realistic to expect that your market share in China will eventually approach the levels that you have in the U.S.?

We believe that it will, Jim.

Great. And then can you talk about the rationale for TOR price increases. It seems as if adhesive resins are over-supplied right now. Do you see that excess supply situation being absorbed quickly, or is there something else happening that will tighten that market?

Well, I think I’m going to let Mike give you some color and detail. But I mean, the two things for us is, one, I think, Chinese gum rosin prices now – continued above $2,000 a ton from $2,100 a ton. That’s up from a low of probably $1,300 a ton. It was lower two to three years ago. Hydrocarbon resin prices actually recovered somewhat despite the fact that there’s additional capacity that’s come along. So I think, in general, Mike, we just see better market dynamics, stability and demand for our specific rosin-based products.

Yes, I think that’s a good summary. As Michael indicated, it’s now been around six months where Chinese gum rosin has been above $2,000, driven by the higher energy costs. Hydrocarbon resins at this point have seen some inflation. So we’re optimistic that the backgrounds for a price increase for our products are there. And from the adhesive standpoint, we don’t believe there’s going to be a very significant amount of substitution away from our types of products towards hydrocarbons.

Thank you.

At this time, presenters, there are no further questions in queue.

Okay. Well, thank you, everyone, for your time and interest this morning. We remain very positive about that long-term outlook for our business, and we look forward to talking to you again next quarter. Have a great day.

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