Q3 2019 Earnings Call

October 24, 2019

On slide number two 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 material 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 route lead 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.

Definitions of these non-GAAP financial measures and reconciliations to comparable GAAP financial measures are included our in our earnings release and can be found on the Investor Relations section of our website.

First Michael will comment on the highlights of the quarter and review the performance of our two 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 QNX.

With that I'll turn it over to Michael.

Thanks, Dan and good morning, everyone. Thank you for joining us. This morning, we appreciate your interest and Ingevity.

And the face a challenging macroeconomic headwinds we delivered a strong third quarter performance inline with our expectations.

Our performance chemicals segment was broadly impacted by the global industrial slowdown.

With respect to earnings we realized strong dropped through as we posted a 26% increase and adjusted EBITDA on 16% increase in revenues.

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 SDMA 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 five 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 only engineered polymer business for the full quarter in both 2018 and 2019 cells in the segment were down 11%.

Sells into industrial specialties applications and these include printing Inc.'s adhesives agricultural chemicals, lubricants, and others were down about $14 million or 13%.

On top of the ongoing secular decline in demand for printing Inc.'s. Our results reflect the decision we made in the second half of 2018 to walk away from some printing business in Europe based on sub optimal margins.

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.

We continue to see strong adoption in price improvement for our Ebo therm warm mix asphalt technology Evo therm sales are up 17% for the year to date.

However, this strong for performance was offset by lower export sales as infrastructure spending in several countries has been curtailed in light of economic conditions.

And 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 years pro forma period. The most significant driver was the reduction in monomer sales 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 onetime inventory transition coinciding with the termination of a temporary warehousing and distribution agreement with per store.

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 businesses performance in the second quarter.

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%.

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 opposed adjusted EBITDA margins of approximately 23% for the full year and 29 team.

Turning to performance materials as you can see on slide number six the segment. Once again delivered outstanding performance segment sales in the second quarter were a record $130 million up 35% versus the prior years quarter.

Sales in China continue to accelerate dramatically as automakers moved ahead with previously announced early implementation of scheduled regulatory mandates.

As you know the China six regulatory standard calls for evaporated admission canisters equivalent to those for us EPA tier two.

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 added approximately 70% compliance rate in the third quarter. We expect this rate to be more than 80% by the end of the year.

We're continuing to see strong sales of Ingevity patented U.S tier three and left three gasoline vapor emissions solutions particular, our honeycomb scrubber products in the U.S 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 .

In the quarter performance materials segment, EBITDA were $54 million up $13 million were 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 assist associated with the Zhuhai, China plant scale up.

We have now largely exhausted this higher cost inventory.

In addition, we experienced higher planned 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, an incremental costs year over year.

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 and quarter to quarter performance arising from outage schedules, both hours and our customers and other issues that might be specific to a quarter.

Further the remains our expectation that the segment will deliver slightly accretive margins for the full year end 2019 versus 2018 with further accretion in 2020.

While the level of spend is unfortunate it is proven effective and maintaining our patent protected market position.

Looking long term performance materials segment, we believe that isn't that the inevitable shift by various regions in 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.

Against this backdrop our team of employees has delivered margin accretion lower core SGN, a improved working capital outstanding cash flow and a stronger balance sheet simply put im proud of our team's execution. So at this point ill turn the call over to John Fortson, Executive Vice President CFO and Treasurer.

Thank you Michael Good morning, everyone. We've made a few adjustments and falling pages from our previous 10 point.

As usual I will provide some additional color on our third quarter results review, our capital structure discussed our revised guidance for the year before turning the call back to Michael for some closing remarks.

Turning to page seven as Michael is cover the revenue and EBITDA as a company that segments I will begin at the Ash DNA line on the income statement.

Ashley and eggs up from last year by approximately 18%, primarily reflecting additional costs, both cash and noncash associated with the Kappa Caprolactam acquisition as well as increased legal expenses relating to the defense of our intellectual property.

However, this number is effectively flat on a percentage of sales basis.

So now estimating litigation expenses of around 15 million from 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 asked Yunhang, excluding litigation expenses of $4.4 million and amortization of $6.9 million included an S. United 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 cap acquisition.

The provision for income taxes on adjusted earnings was $18.2 million during the quarter.

Our adjusted tax rate for the quarter was 22.6% and for the nine months year to date was 22.3% our estimated cash tax rate is 8.4%.

As Michael said, we generated outstanding free cash flow of $97 million up 40% versus the prior years quarter.

This is a resulted in increased operating profit and working capital discipline as Michael noted we have consume 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 from lower cost inventory in the fourth quarter.

Turning to slide eight you'll see our capital structure and how that free cash flow was 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 from our term loan or LIBOR, plus 100, and LIBOR plus 150 basis points.

While these term loans $141 million has been hedged euros to be fixed at 1.41%.

The result weighted average interest rate was approximately 3%.

The rate on our senior notes remains fixed at 4.5% and 80 million dollar notional revenue borrowing rate remains at 7.67%.

Net debt as of September Thirtyth was 1.176 billion, our net debt to EBITDA was 2.9 times. This is below our initial annual guidance of three times from the ended the year.

Trade working capital for the quarter fall from the previous quarter 270 million, which is 20% of sales of 200 basis point improvement from last quarter. As we discussed earlier. This is the result of working to our high cost inventory in China, but also due to excellent inventory management and our performance chemicals segment.

Finally, $555 million remain available in our revolver.

Additional information will be available on our Form 10-Q , which we expect to file next week.

If you turn to slide nine 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 in 400 million midpoint to midpoint. This is a 3% decrease from our initial revenue estimate.

We are revising our EBITDA forecast for 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.

Overall for performance materials, we're expecting continued strong performance based as Michael indicated on 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 in free cash flow.

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 US remained challenging and the timing of any improvement is uncertain.

Consequently, we're taking a conservative view and our 2020 planning ensuring that we're 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 six.

As we had 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 monitor market stabilize the use of derivatives grow and targeted applications and with all transition related revenue impacts behind us.

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're 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 is 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 in efforts of our 1700 50 employees worldwide. They are distinct competitive advantage for us we continually very strongly in the long term potential for our company, we hope to share our enthusiasm for Ingevity at this point operator, we'll open up the call to questions.

Thank you Sir.

I will be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad.

Information tone will indicate your line is in the question Q you May press Star too if you would like to remove your question from the Q.

For participants using speaker equipment, it may be necessary to pick up your hands that before pressing the star keys.

Our first question today is from John Mcnulty of BMO capital markets. Please go ahead.

Thanks for taking my question.

With regard to the the expense of China inventory that you working we're 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 were 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 your it sounds like you're largely through this.

Yeah.

Yeah, Joe and I guess now the turpentine prices have really.

Thank you.

How are you thinking about how this plays out say beyond the next quarter, but as you.

Q3 2019 Earnings Call

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