Ingevity Corporation (NYSE:NGVT) Q3 2023 Earnings Call Transcript

Ingevity Corporation (NYSE:NGVT) Q3 2023 Earnings Call Transcript November 4, 2023

Operator: Good morning or good afternoon, and welcome to the Ingevity Third Quarter 2023 Earnings Call and Webcast. My name is Adam, and I’ll be your operator for today. [Operator Instructions]. I will now hand the floor over to John Nypaver to begin. So John, please go ahead.

John Nypaver: Thank you, Adam. Good morning, and welcome to Ingevity’s Third Quarter 2023 Earnings Call. Earlier this morning, we posted a presentation on our investor site that you can use to follow today’s discussion. It can be found on ir.ingevity.com under Events and Presentations. Also throughout this call, we may refer to non-GAAP financial measures, which are intended to supplement and not substitute for comparable GAAP measures. Definitions of these non-GAAP financial measures and reconciliations to comparable GAAP measures are included in our earnings release and are also in our Form 10-K. We may also make forward-looking statements regarding future events and future financial performance of the company during this call.

And we caution you that these statements are just projections and actual results or events may differ materially from these projections as further described in our earnings release. Our agenda is on Slide 3. Our speakers today are John Fortson, our President and CEO; and Mary Hall, our CFO. Our business leads, Ed Woodcock, President of Performance Materials, Rich White, President of Performance Chemicals; and Steve Hulme, President of Advanced Polymer Technologies, are available for questions and comments. John will start us off with some highlights for the quarter, and Mary will follow with a review of our consolidated financial performance and the business segment results for the third quarter. John will then provide an update on guidance followed by remarks addressing our announcement last night regarding the repositioning of our Performance Chemicals segment and its expected impact.

With that, over to you, John.

John Fortson: Thanks, John, and hello, everyone. Let’s begin on Slide 4. As you know, we made an announcement last night to reposition and restructure the company, and this includes the closure of our DeRidder, Louisiana facility, among other actions. These decisions are consistent with our objective of being a top-tier specialty chemicals company and are part of the execution of our long-term growth strategy. We are committed to maximizing the profitability and the earnings stability of the company. And later in the call, I’ll go into detail about how these actions get us closer to our goals. But first, a few comments on our third quarter performance. To level set, last year’s third quarter revenue and EBITDA were the highest ever for our company.

Our Performance Chemicals and Advanced Polymer Technology segments led the way last year with both posting record quarters in a very robust demand environment. This quarter this year, our strongest performing segment was Performance Materials, which posted EBITDA margins north of 50%. We saw modest revenue growth and strong EBITDA drop-through due to increased demand of our automotive activated carbon in both North America and Asia Pacific. Impacts in the quarter from the auto industry strike were very limited. Additionally, the increased demand for hybrids over battery electric vehicles benefited the segment and bodes well for the segment longer term as well. Advanced Polymer technologies saw their volume drop in all business lines across all regions due to the continued industrial slowdown, but the team maintained their focus on profitability, improving their EBITDA margins by nearly 1,000 basis points.

The team is using this time to advance the adoption of our products in new economy markets like bioplastics, where our capital products enable biodegradability in areas such as packaging, agriculture and sustainable fibers for apparel. In Performance Chemicals, payment had another great quarter as international expansion continues with strong adoption of our products progressing in South America. I would say the number of projects the team saw in the U.S. was not as robust as we had hoped is funding from the infrastructure bill was slow to make its way into local levels. But we do expect those dollars will be put to work, and our teams are ready to deliver solutions that use less energy during the paving process, make growth last longer and improve safety for drivers and pedestrians through more reflective markings.

Industrial Specialties continues to feel the impact from the lack of rosin demand, particularly in the adhesive end markets. And during the quarter, we also saw a slowdown in drilling activity, which resulted in weaker oil field sales. The price we’re paying for CTO, as expected, increased in the quarter, reaching approximately 25% of the company’s total cost of goods sold. As a result, even with the addition of Ozark, Performance Chemicals saw lower sales and a sharp drop in EBITDA. I’ll speak more on these market dynamics and how we are responding after Mary finishes a review of Q3 financials. Mary?

Mary Hall: Thanks, John, and good morning all. Please turn to Slide 5. Sales were down 7.5% versus last year as all segments experienced weaker volumes as compared to last year’s record quarter. The drop in volume was offset somewhat by better product mix and Performance Materials and the addition of Ozark sales within Performance Chemicals. Gross profit was down primarily due to higher CTO costs that impacted the Performance Chemicals segment. SG&A, excluding depreciation and amortization, improved to 7.6% of sales compared with 10.8% in the prior year as we began to see the positive impact of cost savings actions taken earlier in the year. Adjusted EBITDA for the quarter was down 20.1% to $110.4 million but we maintained adjusted EBITDA margin of 24.8%, which is in the top quartile specialty peers.

Diluted adjusted EPS of $1.21 is lower than the prior year due primarily to weaker results in Performance Chemicals as well as higher interest expense associated with the Ozark acquisition. Turning to Slide 6. You’ll see we generated free cash flow of $73 million for the quarter as slower CapEx spending and improved accounts receivable turnover offset the inventory challenges we continue to have with CTO and Rasin. With the free cash flow generated, we prioritize debt repayment and we’re able to hold leverage flat to last year even though EBITDA is lower. Last quarter, we announced cost-saving actions expected to result in $35 million in annualized savings, with $20 million expected to be realized this year, and we are on track to reach this target.

Turning to Performance Chemicals on Slide 7. Revenue was down 4.3% as the volume drop in Industrial Specialties was only partially offset by the addition of Ozark and higher pricing and pavement. Segment EBITDA was down 62.4%. As you see in the waterfall, the impact of lower volume was mostly offset by price, but we were unable to recoup the higher cost of CTO. Similar to last quarter, lower volumes are the result of global weakness primarily in rosin-based end markets and particularly adhesives, but also printing inks. We attribute approximately 2/3 of the decline to demand weakness and the remaining 1/3 to product substitution. On the TOFA side, we began to see weakness in oilfield with lower drilling activity during the quarter. Legacy pavement sales were up as a result of higher prices and increased technology adoption in South America, and Ozark continues to have good results with their paint portfolio, although their thermoplastics business line was slower than expected as competitors gain share through price concessions.

Our sales teams are taking the steps necessary to drive thermoplastic growth as we head into next year’s paving season. Turning to Slide 8, sales for advanced polymer technologies were down 38.4% on lower volumes. The volume drop was across all end markets and all regions, as John mentioned. We estimate 70% of the decline is attributed to lower end market demand as customers do not appear to be restocking inventory. The remaining 30%, we estimate as a combination of lower priced product substitution in certain end markets like footwear and competitors moving into our end markets where they normally don’t participate, but have pivoted to in order to move their product. We believe these are temporary headwinds. And as industrial demand picks up, we’ll see a rebound in volumes.

In fact, we have seen incremental improvements since the middle of Q3, which gives us some hope we’ve seen the bottom. However, customer order patterns are such that we don’t have visibility longer than a few weeks out. Even with lower revenue, segment EBITDA was flat, resulting in margins of 26.2%, a 990 basis point improvement over last year. The improvement is primarily due to pricing and lower energy and low material costs, but also includes benefits from the cost savings actions announced earlier this year. Steve and his team have done a terrific job improving the profitability of this segment, and we expect as volumes pick up, that they will be able to sustain mid-20s margins over the long term. On Slide 9, you’ll find results for Performance Materials.

Revenue was up 1.6%, while EBITDA increased 21.7%, benefiting from improved product mix and cost savings actions. While we’re pleased with the margins, we do not expect the segment will maintain 50-plus percent margins on a consistent quarterly basis. We’ll likely have to settle for margins only in the mid- to upper 40s, which is a nice problem to have. The quarter benefited from an improved sales mix of our higher-margin activated carbon into auto applications. As we track battery electric vehicle adoption rates, it does appear that hybrids are becoming more preferred from a consumer standpoint. In Europe, for every BEV registered, there were 2.2 hybrids registered. Similarly, in the U.S., there are nearly 1.3 hybrids sold for every BEV. This trend benefits Ingevity since hybrids contain our activated carbon.

If these trends continue, this will reaffirm our position, which we articulated at Investor Day that the path to all electric vehicles is through hybrids, and this business has a long runway. Results in Asia were strong in the quarter as auto production stabilized and exports increased from China and Korea. — while in North America, the auto industry strikes were not meaningful to our third quarter results. Given the recent positive developments in the negotiations, we currently expect nominal impact of the strikes on our Q4 results. And I’ll now turn the call back over to John for an update on guidance and for more detail on our repositioning of Performance Chemicals.

John Fortson: Thanks, Mary. Please turn to Slide 10. We do not expect industrial markets to recover in the fourth quarter. Therefore, we are lowering 2023 full year EBITDA guidance to be between $375 million and $390 million, free cash flow to between $75 million and $85 million and the net leverage target to remain near these Q3 levels. Directionally, we are seeing our normal Q4 seasonality amplified by the weaker economy. We did see very limited impact of the UAW strike in October. It is possible that these will be made up over the rest of the year, but it could be in Q1 of next year. The paving season in the northern hemisphere will end as the weather turns cold. If this fourth quarter plays out as last year’s did, we expect Performance Chemicals and APT customer buying patterns to slow as we move into the year-end.

While specific impacts of our restructuring actions will be very limited in the quarter and begin in earnest in Q1 of 2024, we will be selling excess CTO in the quarter and expect losses on those sales as we rebalance our inventories and manage our working capital. Turning to Slide 12, we will go into more detail on the repositioning of Performance Chemicals and what it means to Ingevity as a whole. I will start by saying that these actions do not change the strategy we have articulated and that is to be a best-in-class specialty chemical company. As the business is being impacted by significant structural changes, we are accelerating our execution to refocus on our Performance Chemicals segment on our most profitable markets. By taking these actions, we are focusing our resources on our higher-margin, higher-growth products in less cyclical markets.

These products include our Pavement Technologies business, both our legacy payment but also our road markings business and certain industrial and oilfield markets. We are exiting nonspecialty, more commoditized markets that have proven to be very cyclical and price-sensitive many of which are rosin-based such as printing inks and adhesives but also certain oilfield markets. The margins of the PC business have been under significant pressure. By making these changes, we can improve these margins back to the mid-teens as AFA sales ramp up. We are reducing our dependence on CTO. This raw material, while integral to our past has undergone dramatic structural cost changes due to its use in the regulatory-driven European biofuels market. These step function changes in demand and its effects on pricing are not going away.

Ironically, the TOFA from CTO has become so expensive that its use in biofuels is very limited right now as they have cheaper alternatives. But still, this has driven up CTO prices to inefficient levels that can’t be supported in lower-margin chemical markets. We do believe CTO prices will come down from today’s levels, but we do believe also that they will remain high by historical standards and pricing will remain volatile. Only select products can absorb this new cost structure and remain high margin. By closing De Ridder, we will operate a 2-plant network with dual feedstocks. We will operate the Charleston refinery on CTO for now and cross the roll run on AFA. I would draw a distinction between our refinery and other options to produce products for payment in other markets in Charleston.

The derivatization capabilities to support our target markets exist in Charleston, independent of the refinery of CTO. Our ability to expand production at both sites and cross it in particular, ensures we have capacity to address both the recovery in our target markets, but also to grow as demand for our products growth. Both will be focused on these specialty markets and will support the customer with chemistries from a variety of feedstocks, optimized based on cost and availability. If and when it becomes economic for us to enter the biofuels market, we have the capability to do that. The cost savings we expect to realize from our actions are significant $65 million to $75 million of annual savings beginning in 2024. Exiting a facility of DeRidder size takes time, and we expect to cease operations in the first half of next year.

I was in DeRidder yesterday afternoon, and I would like to — would like to take a moment now to say that DeRidder was an integral part of Ingevity’s history operating since 1947. They are a terrific group of people, and we thank them for their service to Ingevity. As we move into 2024, we will continue to assess our plant network and our cost structure to ensure we best support our specialty businesses. The end result of these actions is a stronger and more focused Ingevity. We will be able to focus our capital and resources on our most profitable growth markets, including exciting growth opportunities in Performance Materials and APT. Full company EBITDA margins will improve to the upper 20% range. As a part of these moves, we are streamlining Ingevity overall and restructuring our business and support functions to align with our new focus on specialty markets.

On Slide 13, you will see the breakdown of the company by segment and business hiring. We expect the repositioning of Performance Chemicals will result in approximately $300 million less revenue in the Industrial Specialties business line. What will remain is a company with a revenue mix that is dominated by our higher-margin businesses like Performance Materials, APT and payment. We will be smaller on the top line but more nimble and profitable going forward because of this better mix of businesses. This is a significant restructuring. Ingevity’s headcount is being reduced by almost 20%. With the driver closure, we expect to incur charges of approximately $280 million, with approximately $180 million of the total charges to be noncash. The majority of the noncash charges and 50% to 60% of the cash charges are expected to be recognized by the end of the first half of 2024.

Slide 14 is our road map to the future state of Performance Chemicals. It includes a streamlined manufacturing footprint fed by multiple raw materials. These sites will focus on producing high-margin, high-growth specialty products. In addition to payment and road marketing, we will continue growing the ag disbursements market, and AFA markets, including personal care, home cleaning and animal feed. We will not support low-margin cyclical markets like inks and most adhesives. The remaining RASM we do produce will be used on higher-margin adhesive products blended with AFAs to go into substitutes for TOFA or used in road markings. One of the costs associated with this restructuring will be balancing our future CTO needs with the excess we will receive from our contractual obligations.

With one less plant to run CTO, we will be long CTO for some time. We will sell this excess CTO in the market to both manage inventory and convert to cash. We do expect at least initially to take a loss on these sales and estimate it to be between $30 million to $80 million next year. CTO pricing is in flux, and there are wide bid asks in the market. So this number is hard to pin down now. But as the year progresses, we do expect CTO prices both for what we pay to purchase CTO and for what we sell it for to decrease, particularly in the back half of the year. Additionally, the amount we deem excess, meaning what we have to buy versus what we could use could change. Needless to say, we expect to be sellers of significant volumes of CTO in 2024.

However, we view these sales as distinct from the core operations of the segment. As market conditions change and impact CTO resales, we will update you all. In conclusion, our strategy is to focus on end markets that utilize our higher-margin, higher-growth specialty products, diversify our feedstocks and optimize our manufacturing network. We will be transparent with you each quarter as this repositioning takes place, including sharing our charges and expenses as well as our CTO position and its financial impacts. We are confident that we have a best-in-class specialty chemical business, and we are making — we are working to make it both more stable and profitable. And with that,

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Q&A Session

Operator: [Operator Instructions]. The first question today comes from Vincent Anderson from Stifel.

Vincent Anderson: Thanks. Good morning, everyone. John. So let’s start with Performance Chemicals. I mean the margins this quarter really weren’t too bad given pavement and oilfield mix was a bit lighter than we were hoping for. I’m just curious, was this helped by like a longer tail of lower-priced CTO in the P&L? And then transitioning that into 4Q and the negative guidance change. Does some of the excess CTO sales guidance for 2024. Is some of that also going to be impacting 4Q?

John Fortson: So what’s on the page for CTR resales is really a 2024 number, right? You’re correct that the segment, and I think you’re going to see this both in Q4 and in Q1, you have to remember one thing, we do not — that segment does not benefit from the seasonality that’s tied to the payment business in those quarters, right? So by definition, the quarterly patterns are lower than what you see in Q2, Q3. But it will also be aggravated by rising CTO costs that are, to your point, not in the P&L today, right? We do think those things — those costs will level out at some point in the first half of next year, start coming down. But I would be clear with everyone that Q4 and Q1, we will be dealing with these issues.

Vincent Anderson: Okay. And then going back to the planned CTO sales for 2024. I mean how much of that is just existing inventory given I thought under at least the public portion of your supply agreements, you had out clauses for the closure of plants, and I’m assuming Crosse being converted to AFAs would also qualify as a closure.

John Fortson: We do have out clauses, but they do take time. And we will not be — we will be operating with the volumes that we have today through 2024, right? Or at least that’s what we’re planning for, right? We will be working to manage this situation. What excess CTO we don’t need, we will sell. But we will be buying more CTO than we need through 2024 and potentially into 2025. But our expectation is, is that we will try to manage that.

Mary Hall: So just to add to that, certain contracts do have what I’ll call a wind down…

John Fortson: Based on plant closures.

Mary Hall: Based on plant closures, such that we’re obligated to continue purchasing certain levels of CTO for up to a 2-year period. And then we have more flexibility after that period. So even with the announced closure of DeRidder, we are obligated to take a certain volume of material, and that’s why we’re saying we will be long CTO in — certainly next year. and possibly up to 2 years, and we’ll be doing these resales as needed to balance inventory and working capital…

John Fortson: So a $80 million on that page… Just to make sure that everybody is clear on this, right, would represent an estimate between what we think would be the most punitive buying at a certain price, selling at another that we could be dealing with over the course of next year.

Mary Hall: And we do want to just reiterate, too, that we are continuing discussions with all of our CTO suppliers to better align those existing contracts with our new footprint, if you will.

John Fortson: And I mean, look, we are trying to — as I mentioned in my prepared comments, — we’re going to be working very hard to manage that number down have it eventually go away, right? This is over and distinct from what I would call the operating performance of the sort of core businesses. The — what is hard to pin is exactly what the year will look like in this regard because as I mentioned, we do expect CTO prices to come down, both in terms of what we will pay, right? And then also, that will in turn impact what we will sell it for, right? So I think the first half of the year, we will be incurring these losses on the CTO sales. We would like to think by the back half of the year that we will be more in balance, but I don’t want to over promise to that — so hence, we put up the numbers we have.

Vincent Anderson: Okay. Very, very helpful. And I know that took a little while to get through, but I wanted to ask what hopefully on round.

John Fortson: We want everybody to understand.

Vincent Anderson: Yes. So on AFA, maybe a long question with a short answer. So just pinning you down a bit on the ramp-up, you were running, I think, you said 15% of your oilfield on AFA. Your target is $70 million of sales by year-end and then full utilization on that, call it, 175,000 tonnes of capacity by mid next year, and that gets you breakeven. So what I was hoping we could break all that down into is what the $70 million of AFA revenues equate to from an annualized exit rate for ’23 — and then roughly what kind of exit utilization would that look like so that we know sort of what you’re still going to be filling in the first half of next year?

John Fortson: So here’s what I would say that the numbers that you’re dealing with and we’re out — none of that has changed, really were contemplated prior to the DeRidder closure, right? We are working now to change/accelerate the adoption of AFA into some of our more traditional legacy markets. to offset or to reposition from TOFA into these AFAs. So I am not prepared to sort of change those numbers right now because we’re still working on this, and this is all being contemplated as a part of these actions, but you can expect that as we move into next year that we will come to you with a better vision on that. But clearly, our strategy is going to be moving the ones that are profitable away from TOFA into AFA.

Vincent Anderson: Okay. So no change, but future change would probably reflect some attempt at an acceleration?

John Fortson: Well, it’s going to be more than an attach..

Vincent Anderson: Well, I don’t want to put words –I know you don’t want to promise anything. But okay. All right. Thank you very much. I’ll turn the call over.

Operator: The next question comes from Jon Tanwanteng from CJS Securities.

Jonathan Tanwanteng: My first one is, what utilization do you expect to have at the remaining CTO facility, number one? And number two, do you expect to keep the DeRidder property? Or is it up for sale for some cash maybe just to your plans around the facility after you shut it down?

John Fortson: So we are, Jon, just to answer the first part — or the second part first. We have looked at a pretty full range of options for that asset, and we continue to look at a range of options for that asset. But right now, today, the decision is to shutter it down, right? To get to your other question, what run rate we choose to operate, Charleston at, will depend on the market environment going forward, right? Currently, we’re not actually running the — we haven’t been running the refinery, but we have been running the derivatization plan, right? So that’s part of the reason we want to separate those 2 from — as you think about this, our expectation is as we kind of move forward, we’re probably not going to be running at maximum right away because we’re managing inventories and we’re going to have some inventories that are excess as we sort of exit the rider.

But at some point, we certainly have — we have the capability to run that back up to a full run rate. As I said in my comments, we’ve got Jon, we’ve since checked this sensitivity check us pretty hard, and we’re pretty comfortable that we have the capacity that we’re going to need going forward to support the markets as they return to a more normalized economic environment, right? What’s critical to understanding that, though, is that we’re exiting low-margin cyclical stuff, right? So as the markets recover, we will be able to dial up our capacity both in the DeRidder or excuse me, in Charleston and in Crossed focused on the markets where we have the highest margin opportunities.