U.S. Markets closed

Edited Transcript of NGVT earnings conference call or presentation 24-Oct-19 2:00pm GMT

Q3 2019 Ingevity Corp Earnings Call

NORTH CHARLESTON Nov 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Ingevity Corp earnings conference call or presentation Thursday, October 24, 2019 at 2:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* D. Michael Wilson

Ingevity Corporation - President, CEO & Director

* Daniel Gallagher

Ingevity Corporation - VP of IR

* John C. Fortson

Ingevity Corporation - Executive VP, CFO & Treasurer

* Michael Smith

Ingevity Corporation - Executive VP and President, Performance Chemicals, Strategy and Business Development

================================================================================

Conference Call Participants

================================================================================

* Christopher John Kapsch

Loop Capital Markets LLC, Research Division - MD

* Daniel Dalton Rizzo

Jefferies LLC, Research Division - Equity Analyst

* Ian Alton Zaffino

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* James Michael Sheehan

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* John Patrick McNulty

BMO Capital Markets Equity Research - Analyst

* Jonathan E. Tanwanteng

CJS Securities, Inc. - MD

* Michael Joseph Sison

KeyBanc Capital Markets Inc., Research Division - Former MD & Equity Research Analyst

* Paretosh Misra

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Greetings and welcome to Ingevity's Third Quarter Earnings Call and Webcast. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Dan Gallagher, Vice President of Investor Relations.

--------------------------------------------------------------------------------

Daniel Gallagher, Ingevity Corporation - VP of IR [2]

--------------------------------------------------------------------------------

Thank you, Brock. Good morning, everyone. Welcome to Ingevity's third quarter 2019 earnings conference call. Earlier this morning, we posted a presentation onto the Investors section of our website. If you haven't already done, so I'd encourage you to download this file so you can follow along on the call. You can find it by visiting ir.ingevity.com under Events and Presentations. For participants who are logged into our webcast, the slides should be visible in the online viewing pane and also available to download.

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 the 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 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 review the performance of our 2 segments. John will discuss our current financial status and our revised guidance for the year, then Michael will make some closing remarks before we open the line for questions. Mike Smith, President of Performance Chemicals and Ed Woodcock, President of Performance Materials will join the call for Q&A.

With that, I'll turn it over to Michael.

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thanks, Dan, and good morning, everyone. Thank you for joining us this morning, we appreciate your interest in Ingevity. If you'll turn to slide number 4, you'll note some highlights for the quarter. In the face of challenging macroeconomic headwinds, we delivered a strong third quarter performance in line with our expectations. Overall revenues in the third quarter were $360 million, up approximately 16% when compared to the previous year's quarter. Our Performance Chemicals segment was broadly impacted by the global industrial slowdown. Offsetting this we had the benefit of additional revenue and earnings from our acquired Engineered Polymers product line formed through the acquisition of the Caprolactone business of Perstorp Holding AB.

At the same time, we saw very strong growth in shipments of our Performance Materials segment's automotive products, accelerated significantly by a step change in orders in China as automakers increased compliance with national China 6 regulatory standards. With respect to earnings, we realized strong drop-through as we posted a 26% increase in adjusted EBITDA on 16% increase in revenues, adjusted EBITDA were $114 million, up $23 million from the previous year's quarter and for the third consecutive quarter, we achieved an adjusted EBITDA margin of 30% or more up 260 basis points versus the prior year. Our SG&A costs, net of IP litigation expenses were down 6.1% and for the quarter, we generated outstanding free cash flow of $97 million, up 40% versus last year's quarter. This reduced our leverage and brought our net debt to adjusted EBITDA down to 2.9 times.

If you turn to slide number 5, you will see the third quarter results for Performance Chemicals. As mentioned, sales in most areas of Performance Chemicals segment were negatively impacted by weak market conditions, especially in Europe and Asia. Segment sales in the quarter were $230 million, up 7% versus the prior year period. This includes the addition of the Engineered Polymers products. On a pro forma basis, which assumes we had owned the Engineered Polymer business for the full quarter in both 2018 and 2019, sales in the segment were down 11%. Sales into industrial specialties applications and these include printing inks, adhesives, agricultural chemicals, lubricants and others were down about $14 million or 13%.

On top of the ongoing secular decline in demand for printing inks our results reflect the decision we made in the second half of 2018 to walk away from some printing ink business in Europe based on suboptimal margins. What's more, sales in this area were affected by an oversupply of alternate materials particularly low priced Chinese gum rosin. Sales of Performance Chemicals products to oilfield customers were down 15% versus the prior year. While our outlook at the end of the second quarter anticipated this business would be down in the second half, we saw a sharper reduction in North American drilling and production than was anticipated. According to Baker Hughes, the US rig count at the end of the third quarter was down 11% versus the second quarter.

Sales to payment applications were up 2.5% in the third quarter, driven by solid growth in North America, up 8% quarter-over-quarter and up 9% year-to-date versus the first 9 months of 2018. We continue to see strong adoption and price improvement for our Evotherm warm-mix asphalt technology. Evotherm sales are up 17% for the year-to-date. However, this strong performance was offset by lower export sales as infrastructure spending in several countries has been curtailed in light of economic conditions.

In the Performance Chemicals segment as I said, we had the benefit of the additional revenue from our Engineered Polymers product line. These results, though, were 25% below the prior year's pro forma period. The most significant driver was the reduction in monomer cells in Europe due to softer demand and increased competition. In addition, sales were negatively impacted by approximately $3.5 million in the quarter due to a one-time inventory transition coinciding with the termination of a temporary warehousing and distribution agreement with Perstorp. Still, after adjusting for this impact on a pro forma basis, Engineered Polymer sales were down approximately 17% from the prior year period. This is consistent with the business' performance in the Q2.

Relatively speaking derivatives demand has remained stronger than for monomers while North American demand is outpacing that in Europe and Asia. On the positive side, margins remained strong and are holding up in the face of the weaker demand. Performance Chemicals segment EBITDA were $60 million, up 22%. On a pro forma basis segment EBITDA were down 9%. Segment EBITDA as reported benefited from increases in volumes, price and mix were partially offset by slightly higher production costs.

As we continue to focus on margin accretion, we've achieved a significant adjusted EBITDA margin improvement of more than 320 basis points to 26%. It is still our expectation that the segment will post adjusted EBITDA margins of approximately 23% for the full year in 2019.

Turning to Performance Materials. As you can see on slide number 6, the segment once again delivered outstanding performance. Segment sales in the second quarter were a record $130 million, up 35% versus the prior year's quarter. Sales in China continued to accelerate dramatically as automakers moved ahead with previously announced early implementation of scheduled regulatory mandates. As you know the China 6 regulatory standard calls for evaporative emission canisters equivalent to those for US EPA Tier 2. The substantial increase in sales occurred despite light vehicle production that was down in China, speaking to the current importance of the regulatory drivers versus auto demand for this business.

Through August, China light duty vehicle production was down about 13% or roughly 2.2 million vehicles versus the prior year. In our estimation China's automakers were at an approximately 70% compliance rate in the third quarter. We expect this rate to be more than 80% by the end of the year. We are continuing to see strong sales of Ingevity's patented US Tier 3 and LEV III gasoline vapor emission solutions, particular our honeycomb scrubber products in the US and Canada. We estimate that the industry is at or above the mandated compliance rate of 80% for the 2020 model year.

And similar to the situation in China, this sales increase occurred despite a decrease in light vehicle production. North American vehicle production was down 2.1% through September.

Lastly, in the quarter, we saw an increase in sales in the European Union as the industry implements the Euro 6d standard despite light vehicle sales in the EU that were down 3.6% through August. In the quarter, Performance Materials segment EBITDA were $54 million, up $13 million or 30% versus the prior year segment EBITDA. As discussed, we saw impressive volume increases along with solid price and mix gains in the segment. These were partially offset by the consumption of higher cost inventory associated with the Zhuhai China plant scale-up. We have now largely exhausted this higher cost inventory.

In addition, we experienced higher plant spending related to planned maintenance outages at several facilities and incurred higher legal expenses associated with protecting our intellectual property. Combined, these items resulted in approximately $5 million in incremental costs year-over-year. Incremental legal costs alone were $3.5 million which impacted segment EBITDA margins by roughly 270 basis points.

As reported, segment EBITDA margins were 41.6% in the third quarter versus 43.2% in the prior year period. Just as a reminder, it's important to evaluate margins in this segment on an annual rather than quarterly basis due to the potential for lumpiness in quarter-to-quarter performance arising from outage schedules both ours and our customers and other issues that might be specific to a quarter. Further, there remains our expectation that the segment will deliver slightly accreting margins for the full year in 2019 versus 2018 with further accretion in 2020.

With respect to the higher legal costs in defense of our intellectual property, we anticipate full year litigation spend now of roughly $15 million. While the level of spend is unfortunate, it has proven effective in maintaining our patent protected market position. The merits of our cases are strong and importantly, we believe that our legal actions are having the desired effect that is that are patents are being respected in the marketplace. Looking at long term at Performance Materials segment, we believe that the inevitable shift by various regions and countries to more stringent regulatory standards will continue to fuel growth in this segment well into the future.

What's more, we're confident that our technological expertise in this application will enable us to continue providing leading-edge solutions that meet these regulatory demands. Finally, before turning the call over to John, I'd like to compliment our team of employees in both segments and across the company for their execution. Like many other companies, we are facing a difficult macroeconomic environment. This makes it even more important that we execute on what we can control. Against this backdrop, our team of employees has delivered margin accretion, lower core SG&A, improved working capital, outstanding cash flow and a stronger balance sheet. Simply put, I'm proud of our team's execution.

So at this point, I'll turn the call over to John Fortson, Executive Vice President, CFO and Treasurer, for a more detailed review of our financial status and our guidance for 2019. John?

--------------------------------------------------------------------------------

John C. Fortson, Ingevity Corporation - Executive VP, CFO & Treasurer [4]

--------------------------------------------------------------------------------

Thank you, Michael, and good morning, everyone. We've made a few adjustments to the following pages from our previous template. As usual, I will provide some additional color on our third quarter results, review our capital structure and discuss our revised guidance for the year before turning the call back to Michael for some closing remarks.

Turning to Page 7, as Michael has covered the revenue and EBITDA of the company and its segments, I will begin at the SG&A line on the income statement. SG&A is up from last year by approximately 18%, primarily reflecting the additional costs both cash and non-cash associated with the Capa caprolactone acquisition as well as increased legal expenses related to the defense of our intellectual property. However, this number is effectively flat on a percentage of sales basis.

We are now estimating litigation expenses of around $15 million for the full year. We did spend a bit above this trend over the past quarter due to higher activity associated with various litigation proceedings. Our core SG&A, excluding litigation expenses of $4.4 million and amortization of $6.9 million included in SG&A from the acquisitions, was actually down 3.3%, reflecting our continued focus on cost discipline across the company. Net interest expense for the quarter was $12.1 million as a result of the increased debt associated with the Capa acquisition. The provision for income taxes on adjusted earnings was $18.2 million for the quarter.

Our adjusted tax rate for the quarter was 22.6% and for the 9 months year-to-date was 22.3%. Our estimated cash tax rate is 8.4%. Diluted adjusted earnings per share were $1.46, up 27% from the quarter a year ago. We did buy back 40,000 shares in August at an average price of $77.72. Approximately $389 million remain available for repurchases under our current authorization.

As Michael said, we generated outstanding free cash flow of $97 million, up 40% versus the prior year's quarter. This is a result of increased operating profit and working capital discipline. As Michael noted, we have consumed the vast majority of the higher cost inventory associated with our ramp-up in China a bit earlier than expected due to demand. We will realize the benefits of lower cost inventory in the fourth quarter.

Turning to Slide 8, you'll see our capital structure and how that free cash flow has aided our net debt ratio. Our borrowing rate at the end of the quarter for our revolver was LIBOR plus 150 basis points and the borrowing rates of our term loans are LIBOR plus 100 and LIBOR plus 150 basis points. Of these term loans, $141 million has been hedged in euros to be fixed at 1.41%. The resultant weighted average interest rate was approximately 3%.

The rate on our senior notes remains fixed at 4.5% and the $80 million industrial revenue bond borrowing rate remains at 7.67%. Net debt as of September 30 was $1.176 billion. Our net debt to EBITDA was 2.9 times. This is below our initial annual guidance of 3 times for the end of the year. Trade working capital for the quarter fell from the previous quarter to $270 million which is 20% of sales, a 200 basis point improvement from last quarter. As we discussed earlier, this is the result of working through our high cost inventory in China, but also due to excellent inventory management in our Performance Chemicals segment. Finally $555 million remain available in our revolver. Additional information will be available in our Form 10-Q, which we expect to file next week.

If you turn to Slide 9, you'll find our revised guidance for the year. We are revising our guidance for sales to between $1.28 billion and $1.3 billion and adjusted EBITDA between $390 million and $400 million. Midpoint to midpoint, this is a 3% decrease from our initial revenue estimate. We are revising our EBITDA forecast to the lower end of our initial range communicated at the start of the year. Midpoint to midpoint, this is a $5 million or 1.25% decrease in our EBITDA guidance for the year. Incorporated into this revised guidance, are assumptions that the macroeconomic environment will persist and will continue to impact our Performance Chemicals segment in what is typically a seasonally slow quarter. For Performance Materials, we're expecting continued strong performance based, as Michael indicated, on a China adoption rate near 80% and we will continue to sustain higher litigation costs related to our IP.

We are maintaining our guidance on our tax rate capital expenditures and free cash flow. Lastly, we are committed to driving down our net debt ratio and are now targeting somewhere below 2.8 times by the end of the year.

With that, I will now turn the call back over to Michael.

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [5]

--------------------------------------------------------------------------------

Thanks, John. Since we will not provide forward guidance for 2020 until our fourth quarter earnings call in February, given the current business environment, I thought I'd take this opportunity to provide some preliminary more general perspectives on next year. Sitting here today, global macroeconomic conditions, particularly in industrial production and outside of the U.S. remain challenging and the timing of any improvement is uncertain. Consequently, we are taking a conservative view in our 2020 planning ensuring that we are placing sufficient focus on both cost control and growth as well as a premium on execution.

We expect to deliver strong performance again in our Performance Materials segment based on continued regulatory-driven growth in China, North America and other regions of the world. Relatively speaking, growth should be the fastest in the first two quarters of the year as automakers complete the transition to 100% compliance with China 6.

As we have previously communicated, we would also expect continued margin accretion in the segment due to volume and mix benefits, which will continue to be tempered by the higher litigation costs. However, we expect performance across the Performance Chemicals segment to be mixed. Engineered Polymers should post solid year-over-year growth as monomer markets stabilize, the use of derivatives grow in targeted applications and with all transition-related revenue impacts behind us. We also anticipate that sales to pavement technologies customers will return to more normalized growth again led by North America and the continued adoption of our innovative Evotherm warm-mix asphalt technology.

On the other hand, the outlook for oilfield drilling and production activity will be softer in the absence of some recovery in crude oil prices. This view should be consistent with what you are hearing from major oilfield players. And finally, sales to Industrial Specialties end use markets are going to remain challenged at least for a few more quarters as rosin markets remain weak and as we transition out of the European distribution arrangement we have previously disclosed. Our free cash flow will be stronger next year due to higher operating earnings and lower capital requirements. Our near-term focus remains on delevering our balance sheet to targeted ranges.

In sum, we believe that the diversity of our portfolio combined with strong execution will enable us to deliver solid revenue and earnings growth in 2020, albeit, less robustly than in years past. I appreciate the work and efforts of our 1750 employees worldwide, they are a distinct competitive advantage for us. We continue to believe very strongly in the long-term potential for our Company. We hope you share our enthusiasm for Ingevity. At this point, operator, we'll open up the call to questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question today is from John McNulty of BMO Capital Markets.

--------------------------------------------------------------------------------

John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [2]

--------------------------------------------------------------------------------

Yes, thanks for taking my question. With regard to the expensive China inventory that you were working through the system it sounds like a lot of that is pretty much done. How should we be thinking about the margin lift that you should be getting into the fourth quarter? I know, originally you were expecting it to kind of be a big lift in 2020, but do we get that a bit earlier as we, given that it sounds like you're largely through this?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

John, it's Michael Wilson. As we said, we've worked through the vast majority of that inventory. So it's almost done. That is going to be beneficial. But if you look at the things that I pointed out in terms of higher cost that impacted us in the third quarter, the excess legal spending outages and consuming that inventory, I said that was in total $5 million and $3.5 million of that was litigation. So it was a relatively small impact for the quarter. It will benefit us. But I think rather than focus on what the lift is going to be in 4Q, I would just take you back to what we've said previously that on a full year basis, we expect margins in the segment to be marginally higher than they were in 2018 on a full year basis.

--------------------------------------------------------------------------------

John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [4]

--------------------------------------------------------------------------------

Got it. Fair enough. And then when we think about the pressure that you're seeing from Chinese gum rosin, I guess now the turpentine prices have really tanked, how are you thinking about how this plays out say beyond the next few quarters but as you kind of look to the back half of next year?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [5]

--------------------------------------------------------------------------------

Well, it's my view that gum rosin prices will begin to recover a few quarters out. And that's based upon, sort of, they were down from Q2 to Q3, maybe as much as 20%. But if you look at them over the last quarter, they're really kind of flat and bumping along. I think a lot of what has happened to gum rosin was due to the aberration that happened in the gum turpentine. You know, as we know, we saw gum turpentine spiked to all-time highs because of a shortage of synthetic or hydro-based turpentines. That shortage has now been resolved. And we've seen gum turpentine prices, don't hold me to the exact numbers fall from something like $5,500 a metric ton to under $2,400 a metric ton.

So, I think with the incentive now away from producing gum rosin in order to get turpentine, we will see the supply-demand balance work itself out. It's hard for me to know exactly how much inventory is out there, but we're also now through the fall harvest season in gum rosin. So, I expect over a few quarters, we'll get back to a balanced supply-demand position. It would be my expectation that we should get some lift in those gum rosin prices.

--------------------------------------------------------------------------------

John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [6]

--------------------------------------------------------------------------------

And then maybe just one last question with regard to the longer term, you had indicated you thought environmental standards were going to continue to tighten. I guess, any thoughts on timing in terms of Europe and China? I mean, Europe is even below China in terms of the gasoline vapor emissions standards and China is still below the US, I guess. Any thoughts as to when we might get an update on some of these regulatory requirements?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [7]

--------------------------------------------------------------------------------

It's really just hard to predict, John. We know that both the EU and China are working on what the next iteration of these regulatory standards are going to be. We know that from the work that we do with them that we had -- but so I think that aside, we do know that the next thing that's likely coming is Brazil which is moving to essentially a Tier 2 US type standard beginning over the next couple of years and transitioning through 2025. I just don't want to get out predicting stuff that's not in the public domain and known, but I would reiterate that we have confidence that we will see further raising of the regulatory bar in those countries and we continue to believe as that happens, remember, you've still got 50% of the world's vehicles today, there are on a 1970s US standard, we'll begin to see global harmonization for the other half of those worldwide vehicles.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

The next question is from Ian Zaffino of Oppenheimer & Company.

--------------------------------------------------------------------------------

Ian Alton Zaffino, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [9]

--------------------------------------------------------------------------------

Wanted to just touch on the litigation on the material side, I guess my understanding of the product has always been it's more about a process know-how, but I guess maybe there is a lot more IP than we had thought and how do you think about just your defense of that and IP versus process know-how?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [10]

--------------------------------------------------------------------------------

Thanks. So, this is Michael Wilson. We have both patents and we have process know-how that we would consider trade secret, but specifically, the litigation is regarding infringement activities by 2 competitors that are associated with the patent that we have around our solution for the EPA Tier 3/LEV III solution. So, this is the use of an evaporative emissions canister in conjunction with a bleed device, which is our honeycomb scrubbers and what the patent teaches is the use of those 2 items in conjunction to get that last bit of emissions to drive emissions to a near-zero basis. So, it's not a composition of matter patent or an applications patent, but it's a systems patent on that technology. So that patent runs through March of 2022 and that's what we are defending. I will remind everyone that we also had a new patent issued in August of 2017 that we feel is going to cover a significant portion of future gasoline vehicle engine designs.

So, we have that out there. The primary trade secret technology we have is not on the honeycombs but is on what we would call our BAX 1500 or 15 BWC carbon pellets that are now widely used in Tier 2 and Tier 3 type applications. Those products have been off patent for more than a decade, but the ability to reproduce those by competitive process is very challenging, again, because we have a relatively unique process. Most activated carbons beginning with coal and being thermally activated, we're starting with a hardwood sawdust raw material and chemically activating that totally different process and at the end of the day on a microscopic level, you get a totally different product.

--------------------------------------------------------------------------------

Ian Alton Zaffino, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [11]

--------------------------------------------------------------------------------

Okay. So these are actually products for vehicles, they'll be making their way into the US and Canada, as opposed vehicles that are going to be in -- used and sold in China, correct?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [12]

--------------------------------------------------------------------------------

Yes, the Tier 3/LEV III standard today is only a US and Canada standard.

--------------------------------------------------------------------------------

Ian Alton Zaffino, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [13]

--------------------------------------------------------------------------------

Right. And the lawsuit is surrounding the vehicles that are coming into the US right now?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [14]

--------------------------------------------------------------------------------

Yes. Anything that's infringing that patent for vehicles coming into the US or produced in the US again, there's 2 different cases, one case is more specifically rated around the honeycomb component that's BASF, the MAHLE case is more around the importation of infringing carbons in a canister design that again teaches our patent.

--------------------------------------------------------------------------------

Operator [15]

--------------------------------------------------------------------------------

The next question is from Jim Sheehan of SunTrust Robinson Humphrey.

--------------------------------------------------------------------------------

James Michael Sheehan, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [16]

--------------------------------------------------------------------------------

Good morning. So, your net leverage has come down ahead of schedule thus far in 2019. Can you comment on what you think leverage might be in 2020 and whether you can achieve your targets early then as well?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [17]

--------------------------------------------------------------------------------

Yes, good question. John?

--------------------------------------------------------------------------------

John C. Fortson, Ingevity Corporation - Executive VP, CFO & Treasurer [18]

--------------------------------------------------------------------------------

Yes, no, I mean, listen, we believe that by the middle of next year, we will be within the stated target we've always had 2, 2.5 times.

--------------------------------------------------------------------------------

James Michael Sheehan, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [19]

--------------------------------------------------------------------------------

Thank you. And then going back to the patent infringement stuff, is there any update on the lawsuits themselves? Have you had any favorable news to report?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [20]

--------------------------------------------------------------------------------

I think just first in terms of the lawsuits themselves, there's really been no substantive activity. We do have a case that will be heard in the fourth quarter, that's in front of the International Trade Commission. This is around the one that's around the importation of infringing carbons. We would expect perhaps, to get a preliminary opinion on that as early as January but not to be fully resolved until say the May timeframe of next year. The second case, which is the BASF case, is scheduled for court and a hearing in August of 2020. The MAHLE Federal Court case has been stayed pending the outcome of the ITC case.

So, I would say that there is no substantive updates regarding the litigation itself. I would say, with regard to activity, both BASF and MAHLE have attempted to have the patent overturned through the US Patent Offices, what's called an IPR process or inter partes review. It's an accelerated process to allow someone who is an objector to challenge the patent. BASF's plea for that was refused, they appealed it. It was refused again and MAHLE's action with the US Trademark Office also, which was substantially the same as BASF was also refused. So, that's about the most significant thing I have.

--------------------------------------------------------------------------------

James Michael Sheehan, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [21]

--------------------------------------------------------------------------------

Very helpful. And finally, on your adsorbed natural gas longer-term opportunity, can you talk about any progress you're seeing there and when might that product be commercialized?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [22]

--------------------------------------------------------------------------------

Yes, the pilot program that we previously announced with SoCalGas in California is underway, so we're waiting to get some of the data back from them in terms of their use and how the vehicles performed on the road for them with regard to emissions and fuel economy et cetera. So remain excited about that. In addition, we've been continuing to work to put other pilots in place and we have I think 3 that you'll probably be seeing announcements on sometime either later this quarter or early in 2020.

--------------------------------------------------------------------------------

James Michael Sheehan, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [23]

--------------------------------------------------------------------------------

Thank you.

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [24]

--------------------------------------------------------------------------------

I think it in terms of commercial revenues, Jim, we're still out a couple of years at least.

--------------------------------------------------------------------------------

Operator [25]

--------------------------------------------------------------------------------

The next question is from Mike Sison of Wells Fargo.

--------------------------------------------------------------------------------

Michael Joseph Sison, KeyBanc Capital Markets Inc., Research Division - Former MD & Equity Research Analyst [26]

--------------------------------------------------------------------------------

Guys, nice quarter. In terms of Performance Materials, it looks like the first half of next year is going to be pretty strong and margins are going to continue to expand. How is your capacity? Is it at some point you need to add more capacity as you get through next year?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [27]

--------------------------------------------------------------------------------

No, we're in good shape, most of the capacity or all the capacity additions that we need for the demand we're projecting over the foreseeable future, we've got the capacity in place with a project that we're completing as we speak at our Covington facility in Virginia. So that's one of the reasons that cash generation should step up again next year is because our demands for capital should be reduced.

--------------------------------------------------------------------------------

Michael Joseph Sison, KeyBanc Capital Markets Inc., Research Division - Former MD & Equity Research Analyst [28]

--------------------------------------------------------------------------------

Great. And then in Engineered Polymers, when you think about where you're going to end up pro forma for the full year, you know -- you're going to be down obviously. How much down pro forma do you think you're going to be and how much of that is coming from sort of the derivatized and then the monomer side and then as you look into 2020, how much of the growth can you generate year-over-year from just moving to more derivatized growth and I guess what's the leverage if demand gets better for that business?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [29]

--------------------------------------------------------------------------------

Yes, I think, Mike, first of all, the vast majority of the year-over-year declines is in the monomer area. I don't have the numbers directly in front of me, but probably accounting for 60% to 70% of the decline is probably in monomer versus the downstream products and I may be understating that a little bit. I think in terms of the year-over-year comparisons, the worst comparison is behind us, which was Q3 I think the year-over-year comparison will improve as we move sequentially into Q4. I mean, first of all, the comp is lower. So that makes it easier, but I think also we'll have, we don't have this recurring $3.5 million hit that we had in Q3.

So both of those things should play to the favor of the ability to deliver a better performance and sequential growth. And then I think as we roll into 2020, I don't want to get specific about the growth, but we do expect that business will show solid growth at the revenue line year-over-year in 2020 versus 2019, based on the things that I talked about stabilization in monomer, new derivatives application and not having these one-time revenue impacts related to the transaction.

--------------------------------------------------------------------------------

Michael Joseph Sison, KeyBanc Capital Markets Inc., Research Division - Former MD & Equity Research Analyst [30]

--------------------------------------------------------------------------------

Right. And then just a quick follow-up on the monomer side is it significantly oversupplied and why do you think it could stabilize as you, as you head into next year?

I'm going to let Mike Smith take that.

--------------------------------------------------------------------------------

Michael Smith, Ingevity Corporation - Executive VP and President, Performance Chemicals, Strategy and Business Development [31]

--------------------------------------------------------------------------------

I wouldn't say that it is significantly oversupplied, I think that a pretty significant impact, as we've mentioned previously, is we had a competitor that last year was not running and they got their site back up and running and when they did they went out starting beginning of this year and through the second and third quarter to regain that share. And I think what we've seen now is more of a stabilization of -- in the monomer market that we have experienced and project that to continue next year.

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [32]

--------------------------------------------------------------------------------

So, Mike, I think the other thing just to point out is, I mean clearly there is weakness of demand and I do think it's more of a demand issue than a supply issue. You also have to recognize that our 2 major competitors DAICEL and BASF, BASF has internal demand for caprolactones and because of the macro environment, their internal demand is less than it typically would be as they would use that as a raw material for other products. So that internal demand is down as well as external demand and the same is true for DAICEL, they have a more similar manufacturing process to ours, but they can take and direct the peracetic acid that they're producing to different value chains and because there is less demands in the other value chain currently they have more of this product available to put into the merchant market. So an improvement in the macro environment, not just for caprolactones but for all these other products and end-market applications will lift everything up. So that's what we're waiting to see, but as we see here today, we don't see improvement in the macro for the balance of the year at a minimum.

--------------------------------------------------------------------------------

Operator [33]

--------------------------------------------------------------------------------

The next question is from Jon Tanwanteng of DJS Securities.

--------------------------------------------------------------------------------

Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [34]

--------------------------------------------------------------------------------

First, can you break out the components of the changes to guidance? If I use the midpoint it's $40 million reduction in revenue but only $5 billion in EBITDA or kind of a 12.5% decremental margin. How does that reconcile? Is it just mix? Are your carbon expectations higher than they were before and just a little bit more of the chemicals, low margin stuff going away?

--------------------------------------------------------------------------------

John C. Fortson, Ingevity Corporation - Executive VP, CFO & Treasurer [35]

--------------------------------------------------------------------------------

No, that's right, I mean it's -- look, at the higher level, the materials business is outperforming how we saw things and the chemical business is coming in a lighter, but there is definitely a mix improvement even in the chemicals business partially because of Capa but also when you look at sort of the relative declines pavement is the strongest performer of the businesses so you get that lift.

--------------------------------------------------------------------------------

Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [36]

--------------------------------------------------------------------------------

Okay, great. And then how much did you increase your litigation expense expectations by?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [37]

--------------------------------------------------------------------------------

I think at the end of the second quarter we were sort of ranging $10 million to $15 million. We're now saying it's at the high end of that range and as John pointed out in Q3, we probably had a spend rate that was a little bit above that, just as we prepare for this ITC case, and in this quarter, but again we're sort of pointing to $15 million on a full-year base.

--------------------------------------------------------------------------------

John C. Fortson, Ingevity Corporation - Executive VP, CFO & Treasurer [38]

--------------------------------------------------------------------------------

It is lumpy quarter by quarter, Jon, and difficult to predict.

--------------------------------------------------------------------------------

Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [39]

--------------------------------------------------------------------------------

Okay, great. And then finally, was there a timing component to the strength in carbon materials? Did any region specifically China buy more materials than they were actually building cars or just trying to get a sense of, if that $130 million that you did in Q3 holds up or even improves in Q4, given your comments on the increasing penetration?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [40]

--------------------------------------------------------------------------------

Well, like, as we pointed out in the prepared remarks, I mean, vehicle production in China is down through, I think it's September, August by 13%. So if you kind of annualize that you're talking about production down more than 2.5 million vehicles from the 2018 rate. So we don't expect that increasing. We don't think that inventory is being built. If anything, I think they've worked hard to sell off China 5 vehicle inventory. So I don't really see that as an issue, but what we did say is, look, I mean, they had to be at a 60% compliance rate at least what they committed to, by the beginning of the third quarter. What we're saying is that we believe that across the third quarter, they average closer to 70% compliance. So they are a little bit ahead of that and in my comments, I also said that by the time we get to year-end, we expect they're going to be at a closer to an 80% compliance. So I think you have to factor that into your model.

--------------------------------------------------------------------------------

Operator [41]

--------------------------------------------------------------------------------

The next question is from Chris Kapsch of Loop Capital Markets.

--------------------------------------------------------------------------------

Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [42]

--------------------------------------------------------------------------------

One question about your comments. Looking to 2020 about prospects in the oilfield technologies market and look, I guess there is not much visibility and so I get that -- but in the scenario where rig counts are down again and or linear feet drilled might be down or maybe efficiencies are higher, if there is less demand for derivatized TOFA, I'm just curious how you guys might sort of pivot in response to that. Would you be more inclined to throttle back your CTO refining rates to produce just less TOFA or would you just derivatize less of it for that particular application and sell more TOFA into the market? Do you have a sense for how you might approach that scenario? What the implications might be with the cost of the network.

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [43]

--------------------------------------------------------------------------------

The short answer is that we run to rosin. So we're running to rosin demand and TOFA, we either sell in derivatized or underivatized but where we derivatize the vast majority of the rosin, we're probably only derivatizing 40% to 45% of the TOFA. So if there is not demand for those products in oilfield we'll either move them to other applications or we would sell it as underivatized TOFA. There are markets out there for TOFA.

--------------------------------------------------------------------------------

Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [44]

--------------------------------------------------------------------------------

Okay, so you'd be more inclined to -- got it. That's helpful.

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [45]

--------------------------------------------------------------------------------

I think as a more general comment, not specific to TOFA, but we are going to run our operations to demand. We're going to be sure supply matches demand. We're not doing anything else.

--------------------------------------------------------------------------------

Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [46]

--------------------------------------------------------------------------------

Fair enough. And then I don't want to beat the IP litigation to death but it was interesting to hear you make the comments that -- and I think it's important that the inter partes review was rejected not once but twice. My understanding of that and obviously not an IP attorney but the case that they might have -- must have tried to make was that there were some prior art and that would be the basis for invalidating your patent and good to hear that that's absolutely not the case. I mean, I thought you guys kind of invented this application so hard to imagine that there was prior art in that nuanced application. But I think what -- the fact that the -- and I'm talking about the BASF one, not a hearing until August. Is that to suggest that you guys were not successful in getting a preliminary injunction from them sampling their sort of me-too I guess mousetrap? Thank you.

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [47]

--------------------------------------------------------------------------------

Yes. That preliminary injunction ruling came a couple of quarters ago, Chris and there was a very high hurdle on that. So there were low expectations regarding that. So the hearing has been scheduled and unfortunate from our perspective is that court cases or so backlogged and they scheduled it where they have. To your earlier point, we fully agree about the patent office's action to refuse to hear the complaint to overturn the patent. I would say in addition to that, the other thing you have to keep in mind is that we've had additional patents issued during the same period of time. The August 2017 one and divisionals to that patent. So I think that also speaks to the strength of the prior art. The fact that the patent office continues to grant us other patents in divisionals.

--------------------------------------------------------------------------------

Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [48]

--------------------------------------------------------------------------------

And just to be clear for the August trial, the goal there is to get an injunction from them sampling your product prior to your patent expiration at this point? Is that right?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [49]

--------------------------------------------------------------------------------

My objective is to get them to quick any infringing activity, to respect the patent and hopefully to recover my costs and damages if there are any.

--------------------------------------------------------------------------------

Operator [50]

--------------------------------------------------------------------------------

The next question is from Paretosh Misra of Berenberg Capital Markets.

--------------------------------------------------------------------------------

Paretosh Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [51]

--------------------------------------------------------------------------------

Question on your feedstock costs, so how does the pulp and paper market affect your business? Because pulp prices have been fairly weak and if they stay weak next year, how do you think it might change your cost side next year?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [52]

--------------------------------------------------------------------------------

We're really disconnected from the cost of pulp. Obviously, the production of pulp and supply of pulp matters because the amount of CTO that's produced is directly related to the amount of pulping that goes on particularly for softwood pulps in the Southeastern U.S. So if you think about what's happened this year demand has been down so -- or supply has been down. Some capacity on the pulping side has been taken off so that's resulted in less CTO available in the marketplace. I would probably say low to mid --mid to high single-digits on a percentage basis. So that can have the impact of tightening supply-demand for CTO and a secondary impact on prices for CTO. But our price is really our market based on the availability of CTO and or index to energy in the case of our GP supply agreement.

--------------------------------------------------------------------------------

Paretosh Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [53]

--------------------------------------------------------------------------------

I see. And then the follow-up on your oilfield business. So if the rig count is falling, are there any other levers that you can pull to offset that like increase market penetration or looking for newer markets outside the U.S.?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [54]

--------------------------------------------------------------------------------

Yes. We put more emphasis on production if drilling, in particular, is down and we've talked about in prior quarters, we're working hard to diversify the business geographically, specifically some new business we've developed in the Mideast. I think that we're actually going to see some benefit from that in Q4. Whether we're able to carry that over into 2020 we have to see. But we do think it's important we continue to globalize that base of business. And the best thing we can do is just continue to bring innovation to our products that improve efficacy for our customers as well, just to win our share of the business.

--------------------------------------------------------------------------------

Operator [55]

--------------------------------------------------------------------------------

(Operator Instructions) Our next question is from Dan Rizzo of Jefferies.

--------------------------------------------------------------------------------

Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [56]

--------------------------------------------------------------------------------

One quick question. I understand you have a different process to produce activated carbon but what safeguards are in place to stop Chinese competitors from stealing or replicating that process? I mean is it just they just don't have the wherewithal or what?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [57]

--------------------------------------------------------------------------------

Again, it's a very challenging thing to do. You'd have to recognize there would be substantial capital investments required to develop that process. I mean, the first thing you have to do is to develop a process at the laboratory scale, prove that you can do it, then you've got to make the capital investments. And then if you're successful with that and you're talking about a multi-year timeframe. This is a business where you've got to go win the business sort of vehicle platform by vehicle platform. So we start doing the math on the investment required and the timing and sort of the time value return. It's hard to get there to be honest with you.

--------------------------------------------------------------------------------

Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [58]

--------------------------------------------------------------------------------

Okay, thanks for that. And then you mentioned looking for different geographies for oil and gas -- for oil drilling. I mean is it used in gas at all or can it be used in gas or is that an area you're already in?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [59]

--------------------------------------------------------------------------------

No, we're agnostic in drilling to oil or gas. We're used in both. As long as it's sort of deep drilling complicated where there's high temperatures involved, where they use an oil-based mud that favors our products.

--------------------------------------------------------------------------------

Operator [60]

--------------------------------------------------------------------------------

We have a follow-up question from John McNulty of BMO Capital Markets.

--------------------------------------------------------------------------------

John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [61]

--------------------------------------------------------------------------------

Yes, just 2 quick ones on the Capa assets. Last quarter you had expected this quarter to see a sequential lift up and you didn't. Is it strictly the inventory blip that you saw, and that wasn't necessarily expected? Is that the right way to think about it?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [62]

--------------------------------------------------------------------------------

It is, John. I wasn't going to say that because I didn't want to make excuses, but if it hadn't been for the 3.5 we would have had that sequential uplift. So thanks for pointing that out.

--------------------------------------------------------------------------------

John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [63]

--------------------------------------------------------------------------------

Okay. No, absolutely. And then I guess as a follow-up to that. So when you think -- given your confidence about the Capa business picking up in 2020, I guess what gets you there? Is it just that you've seen the derivatized products being trialed with new potential customers? Are you making certain bets on end markets recovering? I guess what gives you the confidence that you get that incremental pickup?

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [64]

--------------------------------------------------------------------------------

It's mostly the new business on the derivative side and the fact that we have had some revenue impacts since we've owned the business in 2019 that we won't have next year that I think, to a degree, artificially deflate the revenues in this year and all that goes away. But I also expect this monomer situation is going to work itself out. And look, I think it's a good business with good markets that the macro is going to recover and that's going to turn at some point. So I think we just have to have some patience for that, but we continue to have great confidence in what the team is doing there in the backlog of projects and the new product development pipeline and the things that we see coming whether it's bioplastics, medical applications, aerospace, et cetera.

--------------------------------------------------------------------------------

Operator [65]

--------------------------------------------------------------------------------

There are no additional questions at this time. I'd like to turn the call back over to Michael Wilson for closing remarks.

--------------------------------------------------------------------------------

D. Michael Wilson, Ingevity Corporation - President, CEO & Director [66]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Operator [67]

--------------------------------------------------------------------------------

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.