Ingevity Corporation Common Stock

Greetings. Welcome to the Ingevity third quarter earnings report. At this time, all participants are in listen only mode. The question and answer session will follow the formal presentation. If anyone should require operator assistance during this conference, please press star zero from your telephone keypad. Please note this conference is being recorded. I'll now turn the conference over to Bill Hamilton, treasurer and head of investor relations. Bill, you may now begin.

Thanks, Rob. Good morning, everyone. Welcome to Ingevity's third quarter 2021 earnings conference call. This morning, we posted a presentation on our investor site that you can use to follow today's call. It can be found on ir.ingevity.com under events and presentations. Any projections or goals we may include in our presentation today are likely to involve risks we've detailed in our earnings release, our SEC filings, and the forward-looking statement you see here on slide two. I'll also refer you to our earnings release and presentation for disclosures and reconciliation of non-GAAP measures we use when discussing our results. Our agenda is on slide three. With me today are John Fortson, President and CEO, Mary Hall, our CFO, Mike Smith, President of Performance Chemicals, and Ed Woodcock, President of Performance Materials. First, John will comment on the highlights of the quarter. Mike and Ed will review the performance of our two segments. Mary will comment on our current financial status. And lastly, John will discuss a revised guidance for the year. With that, I'll turn the call over to our CEO, John Fortson.

Thanks, Bill, and good morning, everyone. Thank you for joining us. If you turn to slide four, you'll note some highlights for the quarter. Overall, I'm really proud of the way Ingevity has performed this quarter. We continue to grow many of our current businesses in the face of raw material inflation and supply chain headwinds, while also advancing our new product initiatives. Sales in the third quarter of 2021 rose 14% to $377 million compared to the previous year's third quarter. Our third quarter results were driven by significantly higher performance chemicals volumes in engineered polymers and industrial specialties, and were supported by price increases across the segment. Engineer Polymer saw increased volumes in Q3 for all product lines. This business has demonstrated robust growth throughout 2021. Our industrial specialties business also delivered very good performance on increased demand, and sales of our pavement technology products are slightly ahead of the prior year's third quarters. The prolonged impact of the global microchip shortage continued to depress automotive production, which negatively impacted sales of our activated carbon products in our performance materials segment. As a result, performance materials sales and adjusted EBITDA were down compared to 2020's third quarter, which is a tough comparable period. This was the quarter last year when demand and production rebounded sharply from pandemic lows. With respect to Ingevity's consolidated earnings, Both our adjusted EBITDA and adjusted EBITDA margin were down from third quarter 2020 due to margin compression caused by the impact of lower sales in our performance materials segment. However, when compared to the more normal year of 2019, margins were essentially flat on EBITDA that grew almost 5%. You will hear more from Mike and Ed, but we continue to advance important initiatives across the companies that are positioning us for long-term sustainable growth. We had our first commercial sales of TOFA into the European biofuels market. An application we anticipate will represent a significant opportunity for us in the future. We have obtained certification for biofuel sales at our North Charleston plant, and the process to expand it to Derrida and Crossit is well underway. We are working to advance our soy-based fatty acid production capacity at our Crossit facility with a goal of significantly more capability in the second quarter of 2022. We are finding increasing market opportunities for this alternate feedstock. We are also expanding our monomer production capacity of caprolactone in Warrington to meet the higher levels of demand for our products, and our plans to add polyol capacity to our deriver plant are on track for Q2 of next year. Our products are even finding their way into the electric vehicle value chain. Our industrial specialties team is selling product to support lithium mining operations. And our engineered polymers Kappa products are used as critical performance-enhancing materials in electric vehicle battery pads to dampen noise and protect the batteries. We are excited to be finding ways to add value in these growth markets. Finally, we are continuing to see increased testing by utility fleets for our A&G technology. Beyond trucks, testing of our large on-site storage tank is largely complete, and we are operational with our methane capture and storage strategic partner, GreenGas USA. You may have recently seen GreenGas announced a 10-year offtake agreement with Enviva. This is their second, their first being with Duke University. Additionally, we published our 2020 sustainability report update last week that highlights Ingevity's ongoing commitment to operating sustainably, bringing high-performing, customer-focused solutions to the market and playing an important role in the global race to lower emissions. Our renewable raw materials and the significant environmental benefits of our technologies give us a competitive edge. I encourage you to read the update, which can be found on the homepage of our investor site. I want to thank the entire Ingevity team for their continued hard work in these challenging times. I continue to be impressed by the drive and determination of our entire team, but particularly the operations and supply chain employees who work smart and safely day in and day out under these trying market conditions. I was able to get to our engineered polymer site in the UK this past quarter to thank them for what has been a remarkable story of supporting recovery in their existing markets and advancing new technology adoption. We are all excited about the opportunities they have in their future. With that, I'll turn the call over to Mike to review the results from Florence Chemicals. Thanks, John.

On slide five, you'll see our performance chemical segment sales in the third quarter were $259 million, up almost 38% versus the prior year period. Across all our businesses, we realized growth through the adoption of the many sustainable and high-margin derivative solutions we offer customers. We're incredibly pleased to see demand for products across our engineer polymers portfolio continuing to grow. Orderly sales in engineer polymers rose over 100%, to an all-time record level due to improved volume for all product lines across the globe and markedly higher demand in automotive and industrial equipment applications. In automotive, we realize strong technology adoption and sales growth in protective coatings and electric vehicle battery pads. In addition, our sales in the bioplastic applications continue to show growth, and we are encouraged by the increasing number of customers who are using these Kappa solutions to meet their sustainability goals. In addition to volume growth, we also realized strong price improvement in engineered polymers, which has been important to offset the inflation in raw material costs. Industrial specialty sales rose 47%. Sales growth in adhesives, oil fields, and lubricants were all up over 60%. Adhesive sales growth was robust in both packaging adhesives and safety road striping. We saw the benefit of Q2 price increases come through in the third quarter, and the business also implemented additional price increases for autolo rosin and tylo fatty acid products, which are in effect for the fourth quarter. Chinese gum rosin prices continue to be higher than levels seen in the last five years, and supply and demand dynamics for rosin-based products and fatty acids remain strong. During the quarter, we saw continued sales of soy-based fatty acid derivatives and straight soy-based fatty acids. These are important steps as we expand our product portfolio and potential end-use applications by adopting raw material feedstocks beyond CTO. We also had our first commercial sales of TOFA into European biofuels and expect demand for this application to grow significantly going forward. Sales to pavement technology applications were up slightly compared to the previous year quarter, driven by continued adoption of our environmentally friendly cold recycling technology. Outside of North America, we realized strong sales growth in Europe, but that was offset by a reduction in sales in China, which we attribute to temporarily reduced local government infrastructure spending, leading to curtailed paving activities. Performance chemical segment EBITDA in the third quarter was 63 million, up 34% versus the prior year quarter due to higher volumes and prices. partially offset by continued inflation of raw materials and logistic costs. I now turn the call over to Ed to discuss third quarter performance material results.

Thanks, Mike. As you can see on slide number six, sales for the segment were down 18% at $118 million. Sales of our automotive activated carbon products were down compared to the third quarter of 2020. reduced by the shortage of microchips that continues to negatively impact global vehicle production. The microchip shortage is disrupting the automotive industry worldwide. In the quarter, North America light vehicle production declined 27% and has been sequentially declining quarter over quarter since the prior year's Q3. North America production remains at a favorable mix of 81% trucks and SUVs to 19% sedans. This truck and SUV mix has been in this range since the beginning of the year as OEMs are directing their limited microchip volumes to their most profitable vehicles, pickups and SUVs. These vehicles are also beneficial for longevity as they typically have larger canisters and multiple honeycombs as part of their evaporative emissions control systems. U.S. light vehicle inventories as of the end of September fell 64% to less than 1 million vehicles compared to 2.7 million vehicles in inventory in September 2020. The decline is even greater when compared to the pre-COVID inventory of 3.6 million vehicles in inventory in September 2019. US and Canada vehicle sales were down 13% in the quarter, reflecting both the lack of vehicle production and the availability of vehicles for consumers to purchase. Additionally, China light vehicle production in the quarter was down 15% and sales were 14% lower versus the prior year quarter. Based on IHS data, We estimate the Q3 impact to longevity of microchip related production losses to be about $22 to $28 million in revenue. We expect the microchip supply issue to continue through the rest of 2021 and into 2022. Lastly, US and Canada Tier 3 implementation is ongoing as some model year 2022 platforms were delayed by the pandemic. Remaining Tier 3 implementations should be completed by the end of the year or early in 2022. Segment EBITDA was $56 million, down 30% versus the prior year period. Despite lower revenue, we maintained strong segment EBITDA margins at 48% in the quarter. In mid-September, we announced our intention to challenge an adverse jury verdict in the U.S. District Court of Delaware. We don't anticipate an immediate impact to commercial sales and aren't aware of a competing certified or tested honeycomb that could replace sales of Ingevity's products immediately due to the multi-year automotive design cycles of OEMs and Tier 1 suppliers. This decision has no bearing on our 649 patent family obtained in the US, Europe, and China to reduce emissions and advance low purge engine technologies like start-stop, turbo, and some hybrid variations that we believe could apply to anywhere from 25 to 60% of future near-zero fuel system designs. Also in September, the U.S. Patent Trial and Appeal Board recognized the validity of a patent in our newer 649 portfolio following a post-grant review that was initiated by a competitor challenging certain claims within the patent related to the use of our standard and specialized honeycomb products. This win is a great outcome for Ingevity as we continue to add to the next generation of emissions control technologies in our performance materials IP portfolio. It recognizes our ongoing investment in research and development of automotive emissions control solutions using specialty honeycombs and canister design. As the world leader in this space, we're committed to continuing to leverage our expertise in complex low purge engine innovations to help our OEM customers meet increasingly stringent emissions targets. I'll turn the call over to Mary for further detail on our Q3 financials and metrics.

Thanks, Ed, and good morning all. Please turn to slide seven. Here you see the healthy increase in revenues, which were up almost 14%. However, you also see the decline in both gross margin and adjusted EBITDA margin due to the reduced sales and performance materials, and the significant mixed shift in revenue versus Q3 of last year with performance chemicals revenue up 38% and performance materials revenue down 18%. In addition, our SG&A was up year over year as we resumed more normal commercial operations, including hiring to fill open positions, increased travel, and investment in growth and innovation resources. We remain focused on prudent cost management while ensuring we can meet the rebound in business activity. Net interest expense for the quarter was $11.6 million, up a bit from last year as we replaced our floating rate revolver borrowing in the fourth quarter of 2020 with a fixed rate bond with an eight-year maturity. Our tax provision on adjusted earnings was $16 million for the quarter, a decrease year over year reflecting lower earnings and also our earnings mix across different geographic locations. Our adjusted tax rate in Q3 was 19.8%, and we estimate our full year 2021 adjusted tax rate will be in the range of 22 to 24%. Diluted adjusted earnings per share of $1.62 are down from $1.79 in Q3 last year, reflecting the lower margin. Turning to slide eight, you'll see we generated solid free cash flow of approximately 75 million in the quarter as we remain focused on disciplined working capital management. We did see inventories and performance materials tick up somewhat in Q3 as the forecast for auto production deteriorated throughout the quarter, and we're managing plant operations to optimize production and inventory as we navigate this dynamic environment. As we previously stated, we will continue to be opportunistic with share repurchases. In Q3, we repurchased about $32 million of shares, and year to date, repurchases totaled about $100 million, or 1.3 million shares. This leaves approximately 312 million available on our share repurchase authorization. Our leverage ratio net debt to adjusted EBITDA was 2.1 times at the end of Q3, flat sequentially, and down from 2.7 times at the end of Q3 2020. Our average cost of debt was approximately 3.6%, and we have no meaningful debt maturities until August of 2023. In summary, our balance sheet is strong. We're balanced and disciplined in our capital allocation, and we have ample liquidity to support our inorganic and organic growth initiatives. And now back over to you, John.

Thank you, Mary. On slide nine, I'd like to review our updated guidance for 2021. Our guidance for the remainder of the year reflects tempered expectations for performance materials and confidence in the continued strong demand for products in our performance chemicals portfolio in the fourth quarter. Our updated guidance for the full year 2021 is sales to be between 1.32 and 1.36 billion, An adjusted EBITDA to be between $405 and $420 million. Throughout the rest of the year, we expect the ongoing shortage of microchips and continued logistics, raw materials, and energy inflation to be headwinds. We're also watching for any other issues that could also impact automotive production. We continue to monitor supply and demand in the market and will pass through costs to ensure we extract the optimal value for our products. Despite these challenges, our team is operating very effectively, and we continue to execute on our strategy. We are being aggressive in the market, both in realizing value for our products but also in finding new applications. We are determined to take advantage of opportunities in this dynamic situation to maximize value today and in the future, and our results reflect this. In closing, I appreciate the ongoing hard work and efforts of our employees worldwide, and we thank them. We hope you share our enthusiasm for longevity. At this point, operator, we'll open up the call to questions.

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue, and you may press star 2 if you'd like to remove your question from the queue. For participants that are using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from the line of John McNulty with BMO Capital. Please receive your questions.

Hey, good morning. This is Caleb on for John. I just had a quick question on the pricing dynamics you're seeing in PC and Q4 and maybe a little bit further out into 2022. especially with what you're seeing in Chinese gum rising. Thank you.

Yeah, thanks. At this point, we are really optimistic that our ongoing price increases will continue to be successful. The market is supporting it. As you mentioned, we've got a supply-demand situation on Chinese gum that remains quite favorable. It's about as good as it's been in the last five years. And so we fully believe we're going to continue to get additional price increases in the fourth quarter and are certainly optimistic as we enter next year that we'll have further opportunities.

Okay, thank you. And then I was just wondering if you could provide an update on some of the longer-term initiatives you're working around regarding like methane capture and transportation and renewables and the like.

Well, we talked a little bit at the front of the conversation. I mean, we're pretty excited about work across all of our, what I would call, 2.0 initiatives, right? We did announce, Green Gas did announce two offtake agreements, but the big one that happened recently is with Enviva. They are a company that makes wood pellets that are used as a substitute for oil. Most of these pellets are sold in Europe. They generate methane. We'll be offtaking that. The good news also is that our technology, the tank that we've been using, has now been cycled through sufficient times where we rate that as being fully commercially viable. So we are out in the marketplace talking to a lot of different customers and a lot of different parts of sort of the methane value chain, and we're going to continue to grow that. And then with regards to the fatty acids, we talked a little bit about that as well. Our focus is on getting the soy – processes in place next year so we can start ramping sales, but we're also looking at other feedstocks while we're focused on soy in the near term. Hopefully that answers your question. Yeah, thank you.

Our next question is coming from the line of John Tanmeting with CJS Securities. Please proceed with your questions.

Hi, good morning, everybody. Thank you for taking my questions. I was wondering, just on the engineered polymers business, how much room do you have to grow there, given the demand, and kind of before you have your capacity come online later next year?

We have ample capacity to meet any anticipated demand. As you may have seen, we recently announced expansion of 20% at our Warrington site for monomer production. We'll have more polyol production coming on into Ritter next year. That will represent about a 35% increase in capacity for polyols. And so we're super pleased with the growth of that business and the outlook for future growth. And we're committed to ensure that we've got all the capacity we need to support it.

Okay, great. And then just on the automotive business, I was just wondering in your discussions with customers, do you see any relief coming anytime soon? Are they expecting it? especially as we go through Q1 and Q2 of next year? Do you expect any kind of sequential increase in production as we had at Q4?

Yeah, you've probably seen, this is Ed, you've probably seen and heard some of the announcements coming out of GM, Volkswagen, and Ford. You know, effectively, their view is that this will continue throughout 2022. Our view is that we're expecting the first half to be roughly equal to our Q3 and Q4 with improvements occurring in the back half. Ultimately, when those improvements occur will be meaningful, but the market at this point is so opaque, it's hard to really understand when those additional chips will come out of supply.

Okay, got it. And if I could do one more, just on the ANG offtake agreement with your partner that you mentioned, I was just wondering how big that was in terms of how much carbon you could sell to support those volumes.

Well, for this particular situation, I wouldn't characterize it as material, right? I think the way we view it is a verification or validation that the business model for methane capture is a good one and a profitable one, and it will validate the technology that can then be used in a lot of different applications by a lot of different potential customers. It's not going to be a big revenue push, but it's a start.

Okay. Fair enough. Thank you, guys.

Our next question is from the line of Daniel Rizzo with Jefferies. Please proceed with your questions.

Hey, guys. Thanks for taking my questions. So, given, you know, the obvious oil production slowdown and its effect on performance materials. I was just wondering why you noted in performance chemicals that auto production is kind of helping drive growth, at least in engineered polymers. I was wondering why there's kind of a difference there. I figured that would be under pressure as well.

Thanks, Dan. I think we've really got two very different situations. Within performance chemicals, it's really all about new technology adoption. And so when you think about The new business we have that's really getting some great penetration in protective films, it's coming from a very low base. And as customers are aggressively adopting that technology, we've got a strong growth there. And then on the other side, we've got additional business in electric vehicles. And so the business for the microcellular polyurethane type applications for electric vehicle battery pads is new. EV sales continue to grow, and we're really pleased that a number of customers are choosing to use Kappa technology in those growth areas within auto.

Okay, thanks. And then something else. So you indicated, and it's obvious that SUV sales, or I think you said 81% sedans, 19%, and that's Some of that is because of the chip shortage leading to automakers to make more trucks because it's more profitable. But when the chip shortage eases, could we see, I guess, a shift back and have much more sedans being produced because of catch-up? And will that have some sort of impact on you guys, if you follow?

Yeah, Dan, this is Ed. I don't think it's going to have an impact when that recovers. You know, we supply canisters for... SUVs, trucks, and sedans, and all of them based on the size of their fuel tanks should be relatively similar, especially for North America, should be relatively similar content. You know, obviously a little bit more content on the light-duty trucks with extra honeycombs on top of those. But from our overall view is, you know, that profitable mix, the OEMs are going to try to hang on to it as long as they can.

Thank you very much.

Our next question comes from the line of Vincent Anderson with Stifel. Pleased to see you with your questions.

Yeah, thank you. So when I'm looking at the planned capacity investments in biodegradable plastics like PLA, for instance, obviously there's some good growth planned in the Western world where you are now, but China's projections are starting to get pretty aggressive. I'm just wondering, are you comfortable with your geographic footprint relative to that kind of regional disparity and growth? Or do you feel like maybe there's an opportunity over the next couple of years to take what you learned from your U.S. investment here and pursue something similar in Asia?

Yeah, thanks. And so, yes, we are comfortable with our footprint. And we're going to make sure that we can support the customers around the world. Now, that said... As you can already see, we're continually evaluating where the best new use of capital expenditure and capacity expansion should be. We're making our first move by making the polyol production here in North America, and I expect that we'll continue to diversify our capacity over time, but You know, with working closely with our customers out of Warrington, we've been able to supply growth in Asia as well as North America, and we'll continue to balance and make the right investments in the right geographies to support the growth of the business.

Yeah, I mean, to be clear, Vincent, we expect to participate in that market, and we will make sure that we are resourced accordingly to support that.

Excellent. Thank you. And then this one's maybe a little left field, but when we think of batteries, we're usually thinking about graphite. But with some of these alternative chemistries that are coming out here, they're using what's called hard carbon. But to me, it seems very similar to your activated product. I'm just curious if you've done any work internally exploring opportunities there or even had any conversations with potential new suppliers in that space.

Yeah, Vincent, this is Ed. You know, obviously, anything that has the word carbon to it, we try to look into the opportunities that are available for us. We have looked at hard carbons. We are looking at hard carbons. Yeah, we have and continue to evaluate whether there's an opportunity for us to bring our technology into those applications.

Okay, excellent. If I could sneak one more in just really quick. When I think about the soy oil investment, I'm just curious, are you producing enough here at this kind of proof of concept level to also start getting comfortable building commercial relationships for those products, or is that not really going to start in earnest until you're fully up and running?

We've begun to initiate the commercial arrangements. We've supplied initial commercial quantities to a number of customers from the product that we made here at our Charleston facility. And so that work has begun. And so we want to make sure that when the CrossFit facility has the capability to ramp up in the second quarter next year, that we're ready to step up sales and production in both supporting derivatives and for the soy-based fatty acid. And over time, you know, that will continue to grow, but we're not holding back in starting those initial commercial engagements to set ourselves up for next year and beyond.

All right. Thanks. That's all from me.

Our next question comes from the line of Ian Zaschino with Oppenheimer. Please proceed with your questions.

Hi, great. You know, can you guys just maybe talk about, I'm trying to think about the auto space in general, Is there inventory of your product in the channel? Has that all been worked through? And, you know, as the business starts to come back and when it does, how long would it take for you to see a ramp? And then also as we look into just this fourth quarter, you know, what should we kind of expect as far as on the auto side, sales sequential, which is third quarter? Thanks.

Yeah, thank you. And I'll talk about the Q4 one if I can first. If you look at IHS data, Q3 chip losses were around 3.5 million vehicles. Looking into Q4, IHS is already projecting 1.6 million vehicles. Losses, but they put a range as well on what the quarter will be anywhere from 2 million losses to 2.5 to 4.0 million losses. So, you know, our view for Q4 is that I think you're going to surpass 2.5 relatively easily because we're one month into a three-month period. But, you know, I think, you know, we'll end up somewhere between that 2.5 million and 4 million losses. But ultimately, as we talked about earlier, beginning to improve in the first half of 2022, and obviously we're monitoring what the OEMs are talking about. Just to get a feel on how opaque this market is, we really are using IHS as the metrics that we look at, but also kind of engaging with the OEMs and our customers to get a better feel for when they feel demand will start to increase

So if I could tag on to that, so generally, Ed, and, you know, add on if I misspeak here, but Q4 is similar to Q3, but we do have some outages as well, kind of our normal outages that we take in Q4. So we take our outages, OEMs take their holiday outages, and there is some chatter around whether those might get extended or not, too, that give us a little caution. Is that fair? Yeah.

Okay. And then as far as, and I'm just looking at sales versus your sales on the material side, I guess your sales arguably fell less in the industry. So just wondering if there is kind of inventory in the channel.

You know, we've obviously continued to operate our facilities. We have increased inventory slightly. But, you know, I think all suppliers to the automotive industry have kind of built inventories to be able to respond to any surge that can occur within the chip supplies. But, you know, ultimately we're going to manage our plants to optimize our inventory going forward. And we'll just have to, you know, make sure that we are – Our inventories are in balance with what the automobile companies' demands are.

Some of the 2EN is mixed, right? Because as their absolute volumes fall off, they are mix-shifting to and continue to produce the SUVs and the trucks, which are bigger users of our carbon and honeycombs, right? So when I look at it, that's explaining a lot of the differential between our sales and like the OEMs, right?

And we also expect the OEMs to build their inventories once the chip shortage alleviates, as Ed mentioned, too.

Perfect. Thank you so much.

Our next questions come from the line of Paritosh Mishra with Berenberg.

Pleased to see you with your questions. Thank you. Good morning. Could you talk about the patent that is expiring next year? As you get close to the March deadline, are you seeing competitors bringing on new capacity? Could that be a risk for next year? I guess that's what I'm trying to get to, or not so much.

Yeah, Prakash, this is Ed. We don't look at it as a risk. We've been anticipating the 844 patent to expire in March for 20 years. But also well prepared for, you know, at this point, we do not see a competitive product certified or tested honeycomb that could replace the sales of our honeycombs immediately. And again, primarily due to the multi-year design cycle, but also the fact that it takes a lot of work and effort to get a product certified honeycomb. So, you know, again, at this point, we just don't see any competitive product out there at this point that would be impacting our revenue going forward.

Thanks, Ed. And then one of your competitors in pine chemicals was recently acquired. So just curious if you're anticipating any changes in the landscape because of that, or is that largely a neutral event for you?

I mean, look, Kartash, we have to approach it as a neutral event, but obviously we're always looking for opportunities in the marketplace, and to the extent there's any disruptions that might occur as a result of that transaction, we intend to be there to take advantage of it.

Got it. And maybe a last one. I think you mentioned some electric vehicle products from your performance chemical segment. Do these products have an aftermarket as well, or it's primarily an OEM business?

It's an OEM business.

Primarily all OEMs. When we talk about the protective films that people in the U.S. at least talk about wrapping their cars for protection, that could be considered an aftermarket application. For both EVs or internal. For any car that you choose to wrap, a lot of them are choosing to be wrapped very early, as soon as they're, before they're getting sold, and others are choosing to, you know, put that protective coating on after their purchase.

I mean, you know, Paratosh, look, we call that out because it's an example of you know, new applications. I think the performance chemical segment more broadly has done a great job of being very aggressive at trying to find new markets and new applications. And, you know, obviously EV set aside its relationship with performance materials. These are attractive high growth markets and we've got multiple entry points across that segment, right? InSpec is working on lithium mining, CAP is working on applications for the automobiles and And we're going to keep looking for areas where we can participate in that market, right?

Got it. Thanks, guys. Good luck with everything. Thank you.

Our next question comes from the line of Michael Sisson with Wells Fargo. Pleased to see you with your questions.

Hi, this is Richard on for Mike. First question, you did a great job in terms of pushing price increases to more than offset raw material cost inflation. Can you just maybe give some color in terms of where you're seeing the impacts on a raw material side as well as on the availability and logistics and how we should think about that? Has it gotten worse heading into the fourth quarter? Stabilized?

Have we not seen it? I mean, it's a tough one to answer. I mean, each segment has its own set of issues, right? But The reality is that we're seeing raw material, and we're just seeing headwinds across the board, right? I mean, transportation costs, everyone's aware. You can turn on the news at night and see all the ships stacked up. We're paying more, right? And our raw materials across the board are really kind of getting inflated. So, you know, we're working hard to offset that. We're no different than any other company out there, and we'll keep doing what we need to do.

Okay, great. And then... On performance chemicals, maybe if you could talk a little bit about within industrial specialties, oil field technologies, I think last quarter you mentioned it was up 40% year over year. Are you still seeing continued growth there, and what's your outlook for that for the rest of the year in 2022?

Yeah, in fact, we saw really strong growth in the third quarter. Now, it's important to remind ourselves that the third quarter of last year was quite low for oil field. But that was an application within industrial specialties where sales growth was up above 50%. As we look forward and we look at the outlooks that get projected by industry experts, the outlook for drilling activity here in North America in the next number of years looks to be growing in quite a solid manner. So we are... going to ensure that we support that business, as well as the ongoing work we've got to expand our geographic footprint beyond North America, especially in the Middle East and China, two markets that represent good opportunities for us to utilize our oil field technology.

Great. And then just finally on pavement technology that is relatively flat versus prior year, maybe you could talk about how we should think about the growth for that business, you know, through the next 12 months.

You know, our pavement technology business, you know, over time has, you know, demonstrated, you know, solid mid to slightly higher top line growth. You know, this year, if it, frankly, even in this quarter, if it hadn't been for, you know, this downturn in China, we would be talking about growth rates that were similar to that. So I think we've got great opportunity to continue the technology adoption and pavements. We've got increasing opportunities to more fully globalize that business. So we're certainly looking to pursue that. And we've got a keen eye on infrastructure and highway bill spending. You know, we certainly hope that significant investment will be placed there. And while we're not sort of counting on that to be any near-term major inflection, it can only be very positive tailwind for that business. So a great business, and I think the opportunities to continue to grow it are quite solid.

Great. Thank you.

Thank you. Our next question is from the line of Chris Capish with Loop Capital Markets. Please proceed with your questions.

Yeah, hi, good morning. So my question is on the TOPA sales into the European biodiesel market. I'm curious, are these in lieu of other TOPA sales volumes or incremental in nature? And assuming the latter, is there any way you could quantify the magnitude? Really getting at is, you know, are these volumes enough for you to sustainably run your domestic refineries at higher rates, which I guess would in turn allow you to produce more TOR, which seems to be in short supply given the gum situation in China. And I guess that would also help unit costs. So looking for some color there.

I'll start it, but then Mike can – we're going to – the current situation allows us to run our refineries at very high rates, regardless of what's going on in the biofuel market. Right. But what I think will happen, Chris, and it's really, as that market evolves and it becomes something that would be valuable from a profit perspective, relative to other places that might park the car, the TOFA, then it's going to become a larger market. But I, I, would not say that we need that production to run our plants at higher utilization levels today?

No, John, not exactly. We have to balance the rosin and TOFA production. I think it's very encouraging to have a new significant source of demand for TOFA. So over time, I think that can only bode well for supply and demand for TOFA, and therefore pricing. Our execution path will be to optimize the profitability of the business. And if the European biofuel opportunity pricing represents the best opportunities for longevity, that's where we'll put the TOFA. If there are other markets that are better, we'll continue to do that. But we wanted to make sure that from a logistic and customer relationship standpoint, that we were well set up to supply that market. So that's what we did. And we got our first sales to... to a large significant customer in the third quarter for TOFA. And we'll see how that progresses going forward.

That's helpful. And just as a follow-up, if I'm interpreting your response, right, it sounds like just the fundamentals in Chinese gum rods have allowed you to increase rates to get more TOR products. Just curious if there's any governors on your utilization rates in the refineries such as the availability of CTO, or should we expect kind of, at least near term, an upward bias in those utilization rates with, you know, with the strength in overall demand? Thanks.

Well, I think that we have an outlook where we're going to continue to see, you know, some growth going forward. But we, as we've also said, you know, the CTO, availability, you know, can become constrained and we're always making sure that whatever CTO that we purchase on the market and from on a spot basis, we can take that and turn that into profitable business. We have, you know, secured enough CTO at this point to achieve our planning for next year. So I think we're in good shape from that perspective. And so, you know, between the inputs and the good output demand we'll, you know, obviously continue to run the business and optimize the profitability for it.

Yeah, I mean, just to be clear, Chris, we have our CTO secured for next year, so we are not going to be CTO constrained. Part of the long-term strategy around SOFA is that by running these processes in parallel, we will actually get incremental yield, and if we can substitute SOFA and some of our products, we will actually have more TOFA to sell in the marketplace. So what we're trying to do is actually enhance the yield overall of the network so the bias would be upward in your lexicon relative to what we know as secured CTO.

Appreciate the color. Thanks.

Thank you. Our next question is a follow-up from the line of John Tanwateng with CJS Securities. Please proceed with your questions.

Hi, yes. I was wondering if you could just talk about your ongoing legal expenses and kind of what your outlook is for that, just in terms of strategy and litigation, you know, costs going forward.

Yeah, John, this is Ed. We're likely to return to a more normalized level, so think of it about as a third of what we had been spending.

Okay, my impression was that was roughly 5 million-ish a quarter. Is that about right?

Yeah, so 15 on an annual basis, so 5 million going forward. That's per year, John. Per year, yeah.

Got it. Okay, thank you so much.

Thank you. At this time, we've reached the end of the question and answer session. May I now turn the call over to Bill Hamilton for closing remarks?

Thank you for your time this morning. You remain incredibly positive about our long-term business outlook. I look forward to talking with you again next quarter.

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