Ingevity Corporation Common Stock

Ladies and gentlemen, hello and welcome to the Ingevity fourth quarter and full year 2022 earnings call and webcast. My name is Maxine and I'll be coordinating the call today. If you would like to ask a question during the presentation, you may do so by pressing star followed by one on your telephone keypad. I will now hand over to your host, John Nypova, Treasurer and Investor Relations to begin. John, please go ahead when you're ready.

Thank you, Maxine. Good morning and welcome to Ingevity's fourth quarter and full year 2022 earnings call. Early this morning, we posted a presentation on our investor site that you can use to follow today's discussion. It can be found on ir.engevity.com under Events and Presentations. Also, 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 measures are included in our earnings release and are also in our Form 10-K. We may also make forward-looking statements regarding future events and future financial performance of the company during this call. And we caution you that these statements are just projections and actual results or events may differ materially from these projections as further described in our earnings release. Our agenda is on slide three. Our speakers today are John Fortson, our President and CEO, Mary Hall, our CFO, Ed Woodcock, President of Performance Materials, and Rich White, President of Industrial Specialties and Pavement Technologies. In addition, Steve Hume, President, Engineered Polymers, will be available for questions and comments. John will start us off with some highlights for the year. Mary will follow with a review of our consolidated financial performance for the fourth quarter and full year. Rich, on behalf of his performance chemical segment co-lead, Steve Hume, will discuss the entire performance chemical segment, and Ed will review the results of performance materials. Finally, John will conclude with our guidance for 2023. With that, over to you, John.

Thanks, John, and good morning, everyone. Thanks for joining us today. On slide four, you will see that Ingevity has much to be proud of in 2022. Both segments posted record revenue in EBITDA. Combined, Ingevity's revenue reached almost $1.7 billion, and our EBITDA was over $450 million. We profitably grew all the businesses in our portfolio. This was despite the challenges of 2022 that were thrown at us as we grappled with energy spikes, inflation, and then fears of a recession. Like many of our peers, the fourth quarter was slower than expected. For us, the quarter was a tale of two halves. October and early November were strong, but starting just before Thanksgiving, we saw a significant deterioration in our order book as customers aggressively destocked inventory in advance of year end, particularly in higher value product lines such as adhesives. Additionally, as China began to reopen, auto OEMs and parts plants in the country ceased production as they dealt with rising COVID infections. During 2022, Ingevity continued to lay the foundations for sustainable long-term growth. Our investments included our purchase of Ozark materials, which expands our reach into pavement markings in the road construction market. We developed several alternative fatty acids, allowing us to diversify our raw material streams and expand into new markets. We certified our TOPA for use in the biofuels market. We added Kappa Polyols capacity for our engineer polymers business at our Derrida, Louisiana site, allowing us to better meet the growing demand for this product. And we continue to develop new market opportunities for our activated carbon through our investments in the electric battery space and renewable natural gas. We did all these things while also returning significant capital to shareholders through our share repurchase program. All these growth initiatives are consistent with our mission to purify, protect, and enhance the world around us. And we received recognition for these efforts in 2022 with a gold ranking from Echovatus and inclusion in Newsweek's list of America's most responsible companies. We invite you to learn more about our ESG efforts by reading our sustainability report found on our website. I'll end my opening comments with a heartfelt thank you to the entire Ingevity team for their perseverance in delivering record performance in 2022. We are now firmly focused on 2023 and are off to the races. With that, I'll turn it over to Mary to discuss the financials.

Thanks, John, and good morning all. Please turn to slide five. As John mentioned, for full year 2022, we posted record sales and EBITDA with sales up nearly 20% to $1.7 billion, and EBITDA up over 7% to $453 million. Adjusted gross profit of $636 million was higher by almost 10%, but margins were down for the year as input costs accelerated faster than our price increases. with a particularly noticeable impact late in the year as sales volumes in certain higher-value product lines fell off significantly in the last six weeks. We kept SG&A costs as a percentage of sales flat, showing that our growth initiatives are being resourced in a disciplined manner. Given the inflation we saw in raw materials, logistics, energy, and wages during the year, We're pleased that we maintained a strong full year EBITDA margin of 27.1%, despite fourth quarter EBITDA of $74 million being heavily impacted by the sudden deceleration of sales due to customer inventory destocking and the COVID-related slowdown in China. Despite the challenging end to the year, our full year diluted adjusted EPS of $6.01 is a record for the company. Turning to slide 6, in the upper left-hand chart, you can see the record sales results as well as the mix of sales per segment. This reflects the strength of performance chemicals in 2022, and given the addition of Ozark, we expect the revenue mix between segments to be similar going forward. We expect to continue to grow revenue in EBITDA in both segments through organic and inorganic growth while maintaining specialty margins. Based on the segment mix, we expect consolidated EBITDA margins in the mid-20s with upside potential if global automotive production recovers faster than we anticipate. The upper right chart shows we invested over $142 million in organic capital spend in 2022 with over 40% on growth projects, and we still generated over $170 million of free cash flow. A portion of that free cash flow was used to repurchase $145 million of shares, as you can see in the bottom left chart. For the year, we repurchased 2.1 million shares and we've repurchased over 6 million shares since becoming a public company. The chart in the lower right shows our net dev leverage. As noted in our last earnings call, we used our revolving credit facility to acquire Ozark, elevating our net leverage to about 2.9 times. We expect to have net leverage back to our target of around 2.5 times by the end of 2023. In summary, the company delivered record performance and strong free cash flow while managing through historic challenges. I'm confident we will continue to deliver growth in revenue and earnings in 2023 while maintaining our strong balance sheet and cost discipline. And now I'll turn it over to Rich to discuss performance chemicals.

Thank you, Mary. Hello, everyone. Turning to slide seven, it was a record year on both revenue and EBITDA in performance chemicals with revenue up 28% and crossing the billion-dollar threshold for the first time. Four-year EBITDA of over $200 million increased 16% over prior year, while our margins declined primarily due to the impact of higher input costs. In addition, Q4 was negatively impacted by significant customer destocking of higher-value products in the second half of the quarter, particularly in adhesives, as well as lower sales in our pavement business as many municipalities had depleted their budgeted dollars for the paving projects prior to year end. Engineer Polymers ended the year strong with revenue in the fourth quarter of $59.6 million, a 41% increase from the prior year's quarter, which helped drive four-year revenue increase of 32% to $244.7 million. Throughout the year, the team saw plenty of inflation in raw materials, freight, and energy prices. they're able to help offset these increased costs with higher selling prices for our specialty products and increased volume due to strong customer demand, particularly in automotive, footwear, and apparel. Sales in each of these end markets grew over 40% from the prior year. The cap of polyol expansion at our Derrida site is up and running, increasing our capacity to support continued growth in 2023 and beyond. Turning to pavement technologies, Revenue for the full year was up 24% to $241.3 million, which includes fourth quarter revenue from our newly acquired road marketing business, Ozark Materials. We continue to see adoption of our payment technology as municipalities are valuing the benefits that our products provide, such as lower energy required to pave, elimination of harmful emissions, and longer-lasting roads. Combine this with their higher reflectivity and long and lasting attributes of our road markings and we believe we're headed toward a strong 2023. Industrial specialties had a strong year increasing revenue by 28% from the prior year demand continues to grow in the high value areas such as oil field, which is benefiting from increased natural gas production and agrochemicals. where our products bring values such as enabling fertilizer to last longer, thus requiring fewer crop treatments. While fourth quarter revenue was up 12% from a year ago, results were negatively impacted by significant customer stocking, primarily in our high-value adhesive business and, to a lesser extent, some supply disruption. In addition to the raw material cost inflation we experienced in 2022, the supply-demand dynamics of a key raw material crude tall oil are changing. You have heard us mention biofuels, which can be either added as a substitute for traditional diesel fuel. There is a directive in Europe to move more of their diesel to biofuel. Crude tall oil, or CTO, which is a key raw material within my segment, is becoming a highly sought-after raw material for the biofuels market. We view the new biofuels market as an exciting opportunity for us, given our expertise in refining CTO. That being said, the market is still developing, and we believe that speculation among new interests and investors is driving increased volatility around the price and availability of CTO. We have long-term contracts to cover the majority of our supply needs, yet we expect the price of CTO to increase compared to the past. As you know, we converted a portion of our CrossFit Arkansas facility to run non-CTO-based alternative fatty acids. which gives us new raw material streams and offers our customers alternative to CTO-based chemistries, as well as opens new markets for us. With that, I'll now turn the call over to Ed to discuss performance materials. Thanks, Rich.

As you can see on slide eight, revenue for the performance materials segment was flat in the fourth quarter at $132.8 million. As the impacts from COVID-19 outbreaks affected not only our operations in China, but also disrupted global auto production. Full year revenue in 2022 was $548.5 million, an increase of 6% versus 2021. The increase was driven by higher volume, which was an encouraging sign as supply chains and chip availability improved. As supply chains normalize and China recovers, We believe this will facilitate increased global automotive production in 2023. EBITDA margins for the year were lower by 230 basis points. The drop is attributed to higher energy and raw material costs. As we noted on our last call, we typically negotiate price with our customers annually early in the year. and these increased costs have been taken into consideration for 2023 pricing. We were pleased to see the European Commission publish their proposed Euro 7 regulatory package for automotive emissions control, which is now being evaluated by the European Parliament and Council in their ordinary legislative procedure. As proposed, it would result in tighter regulations on automotive emissions similar to those enacted in Brazil last year. What that means to Ingevity in simple terms is our activated carbon content per vehicle would nearly double. We were hoping the proposed emission standards would be aligned to the U.S. standards, which are the most stringent in the world, but are pleased with the progress. The Euro 7 proposal includes a July 25 effective date which is earlier than we expected and means we could potentially see the impact as soon as 2024. Also, as many other countries typically follow European standards, we should benefit as those countries tighten their standards as well. I will now turn the call back to John to discuss the outlook for 2023 and for closing comments.

Thanks, Ed. Please turn to slide nine. As we mentioned in our last call, in an effort to increase transparency to investors, we have concluded we should report our engineer polymers business as a separate segment. They are a big part of our future, and we think it is important for investors to be able to see their growth and progress as they make moving into attractive end markets. This reporting change will begin in the first quarter of 2023, and this segment will be renamed as a part of this process. I'm also very excited to confirm the date of our investor day. It will be May 22nd in New York City. Save the date notifications will go out, and if you want to be added to our invitation list, please contact our IR team. We hope to see many of you at the event where we'll discuss the long-term growth drivers in each of the business segments and communicate new long-term financial targets for longevity. Finally, turning to slide 10, you'll see our guidance for 2023. We are guiding revenue to be between $1.9 and $2.1 billion and EBITDA of $495 to $515 million. As we look across our businesses, we expect the performance materials segment to grow its revenue and maintain its mid-40s margins as price increases take effect and global auto production continues to normalize from its depressed levels. Our engineered polymers business, while it has grown its top line, experienced compressed margins throughout most of 2022, primarily due to energy costs in Europe. We expect their profitability to improve due to increased pricing, volume growth, and cost discipline. Our pavement technologies and Ozark businesses will benefit from infrastructure spending tailwinds. Parts of our industrial specialties and markets should continue to grow at attractive rates. In particular, our oil field and adhesive businesses. However, we expect this business will be challenged by significant increases in the cost of its traditional raw material CTO. CTO pricing has risen over the last year and is expected to continue to escalate over the course of 2023. We will address this by continuing to raise prices on our legacy products and also by offering our customers fatty acid alternatives from other plant-based oils such as soy. CTO inflation is being driven by its value in the biodiesel markets. While this developing market is creating volatility and price pressure on CTO, it also represents a large opportunity for us, and we intend to be a participant in this market this year. 2023 has started somewhat slowly, but we expect customer order patterns to normalize and vehicle production to improve. As the year progresses, we expect to see the momentum pick up and to benefit in all segments with growth in revenue and earnings. We hope you share our enthusiasm for longevity, and with that, I'll turn it over to questions.

Thank you. Ladies and gentlemen, if you would like to ask a question, please press star followed by 1 on your telephone keypad now. If you do change your mind, please press star followed by 2. When preparing to ask your question, please ensure that your line is unmuted. Our first question today comes from John McNulty from BMO Capital Markets. Please go ahead, John. Your line is now open.

Hello, John. Yeah, thanks for taking my question. Good morning. So just a couple of questions on the businesses that maybe seem to struggle toward the end of the quarter, so InSpec and maybe the road paving side. On the InSpec side, can you give us an update as to whether the destocking at the customer level looks like it's done yet or is there still more to go? And on the road paving side, Can you speak to, you know, I understand that, okay, annual budgets kind of ran out or, you know, municipalities kind of spent kind of faster than maybe they expected to. I guess, does that restart the clock January 1, or do we see a little bit of a lag as we move through? I guess, how should we be thinking about that and the infrastructure spend bills that may be helping that later on this year?

A couple things, John. We do think it sort of resets, just to answer that, right, because, you know, These types of this business is basically built around annual campaigns right based on funding and budgeting that goes to the customers, but The other thing I would tell you, which I think some people have not fully appreciated in the in the investment community is You know the Ozark business is seasonal just like pavement right and we've always sort of talked about the fact that you have to look at these businesses on an annual basis because Q1 and Q4 can be weak right and It really, I mean, they're what I call the shoulder quarters. I mean, it all depends on the weather and what happens. Obviously, in first quarter, maybe they get going early because the weather's warm. In Q4, sometimes they run a little late because the weather is, you know, the weather continues to hold. In this case, it was really just your sort of normal seasonal shutdowns. But that does lead to the first part of your question, which is destocking. We did notice And I think, you know, you and I have talked about this, and it feels like it kind of runs across a lot of our customers more and more so over the last few years. I think given the uncertainty in the economic environment that's kind of pervaded for the last three or four years, customers are pretty severely destocking, right? They want to set their year-end inventory levels at a certain point. I think when you're in an environment like we were at the end of last year, four or five months ago, where everyone was really calling for a big recession and a lot of anxiety in the marketplace, that causes customers to want to kind of clamp down. And I think we really saw them kind of shut the spigot off right around Thanksgiving, truthfully, right? But, you know, when you get into an environment now where things feel better, customers then have to kind of turn on the order books and, you know, the anticipated price decreases that they thought they might see aren't really materialized and they have to start ordering, right? So we are starting to see that pick up. you know, January was a little softer than we'd like, you know, but I think, you know, we are starting to see that momentum build. And I think it will continue to sort of escalate over the course of the year.

Got it. Okay. No, that's helpful, Collar. And then when you think about the CTO raw material inflation, some of the things going on in that market, it sounds like it's a challenge for you from a cost perspective. I guess, Can you help us to think about, though, if there's any revenue repercussions as well, like that we should be thinking about where, you know, maybe products that in the past, you know, your derivative products or what have you were maybe better solutions for the value that they were giving, but now maybe competitive products may be able to creep in. Is that an issue that we should be thinking about, or is it really more just a cost issue and you need to be able to kind of iron that out over time?

Well, I mean it's really in my mind predominantly a cost issue right, I mean there are obviously revenue changes that will occur, you know, first off, I would say. Look we've known this was coming for a long time right what makes us in a good unique position is that we do have long term contracts. that allow us to ensure a certain amount of supply of CTO to run our facilities right so. But we do buy some in the third-party market, and, you know, it is inflating, and those prices are going up, and that will continue next year, there's no doubt, right? But what we want to be able to do is we've tried to articulate in our prepared comments is we want to be able to offer our customers either a CTO-based product or an alternative from another fatty acid, right? We might even look at historically some of the volatility, as you guys know, follow us have really been on the rosin side of things. And frankly, if we found ourselves in a position where we need to provide rosin alternatives, we would. But where oil prices are and where we think it will go, it will provide some relief for us from the rosin side. And on the fatty acid side, while it's going to be different, we're pretty excited about the opportunities. We talked about the biofuels market. That is a very, very, very large market for fatty acid and not just tall oil fatty acid. But we think we're going to be able to offer our in-market customers kind of a suite of different alternatives. And in theory, we should be able to hold the revenue, if not grow it, as we enter this new market of biofuels, right? So that's our strategy.

Got it. That's helpful. Thanks very much for the call.

Thank you. Our next question comes from John Tanratang from CJS Securities. Please go ahead. Your line is now open.

Hi, good morning. Thank you for taking my question. Just a quick question on the destocking trend. Have you seen that reverse already, or is that something that's expected to be on the come or maybe reverse in Q2? Just an indication of where trends are heading there, and specifically in what end markets. I think you mentioned he says, I don't know if there's any going on in capital or anywhere else, but just across your entire portfolio, if you could do that.

Hi, John. This is Rich. And as John Fortune mentioned, yeah, we saw January a bit soft, but February is starting to pick up a bit, and we expect as we go through Q1 that we'll see that trend continue. And normally the season is higher for us overall in Q2 and Q3 as compared to Q1 and Q4. So that's what we're expecting going forward. And it was mainly in the industrial specialty segment, not so much in our engineered polymers or any of our other segments.

Okay, great. Thank you. And then you mentioned repricing, your annual repricing in the carbon business. But obviously, you ran into difficulties last year when the prices ran up on you. Has there been any change in the pricing formulas or contracts that you have that enables you to adjust a little bit more in real time as you go through the year if that does happen again? Or are you just resetting to the point where you think you've adjusted for those if they happen again?

Yeah, John, this is Ed. Yes, we pushed through pricing effective January 1st, and you know, we were trying to recoup, you know, energy costs as well as raw material increases. And if we're unable to do that, then we will consider additional price increases as we move through the year.

OK, great and then last one for me. Just the implication for the margins in the in the chemicals business. If you're expecting materials to be a little bit better year over year, revenues to be growing, but if it does be roughly flattish, I would assume that the margins are going down in that segment. Is that simply a function of the top line increasing and the margin comes down mathematically, or are you actually expecting a margin decline on a per?

No, look, you're thinking about it the right way, John. I mean, look, you can kind of reverse, do the math, right? I mean, you make some growth assumptions on Ed's business, performance materials, we talked about margins in the mid 40s, which is kind of where they finished last year, right? So you can kind of back into what that looks like for the PC side of things, right? We talked about engineer polymers improving their margins on continued growth, right? I think that growth will come down a little bit from last year because it was pretty explosive, but well above sort of GDP or market growth. Then we talked about the tailwinds that we expect to have and pavement, what you're left with is industrial specialties margins, which we think will come under some pressure, potentially, because of the CTO. So, you know, you know us. We're pretty conservative. You know, we're trying to factor in what we think could be that inflation.

Understood, John. Thanks. I'll jump back in.

But I will say, John, I mean, look, you know, if you look at it over the long haul, we've always maintained that we want to be a specialty chemical business in that, and While we may suffer a little bit next year, our plan is to get those margins back into the top quartile area as we sort of move through these different markets and make some of these adjustments.

Thank you. The next question comes from Vincent Anderson from Stiefel. Please go ahead. Your line is now open.

If we missed you, John, we'll come back. Go ahead, Vince, all right.

Oh, no worries. So you hinted at this already. So as I think about the scenarios for CTO availability over the next few years, we've talked a lot about alternative fatty acid feedstocks, but we really haven't talked about rosin and what it might take for you to maintain your market position there if you were to switch more capacity away from CTO. So just is it feasible for you to process crude gum rosin know for instance out of brazil to backfill some of your tor derivatives and i want to focus on crude because one of the distinguishing characteristics of your more adhesives focused competitor traditionally has been their terpene chemistry so is there some additional opportunity by finding a way to process crude gum well it's interesting john you're being pretty thoughtful um to answer your question

or Vincent, sorry, to answer your question, Vincent, I mean, yes, we have the ability to use other types of rosins and we are looking at those other types of rosins. I'm not necessarily going to go into which ones we are focusing on at this point, but our intention is to continue to be competitive. As you know, and what's kind of interesting, Vincent, we've talked about this, I mean, some of our fatty acids are not that we're looking at are not going to generate the same levels of rosin right that you typically get from crude tall oil but that's not necessarily a bad thing because it allows us to look at other rosins that could be used in the marketplace as substitutes right and we feel better about it just because the price of topa is so high right it gives us the We're not in a bad spot economically to try and look at some of these different markets, if that makes sense.

Sure. No, that checks out. And then, you know, it sounds like a good portion of your high-value product, the stocking that you noted, it sounds like it was mostly in the Rosin value chain, maybe a little bit in pavement there. But where you did see destocking in TOFA derivatives and maybe your outlook for oil field in general as natural gas prices have rolled over. Can you walk us through at a high level what the mix impact looks like today, given current commodity TOFA prices are so high? And I assume, given the timing of the destocking late in the quarter, were you even able to move any of that lost demand into these spot markets? That's a very good question, Vincent.

I mean, you are calling it, that's a very good read. And that's exactly what happened, frankly, right? The destocking predominantly occurred in the rosin-based end markets. TOFA-based end markets continue to remain very robust, and we don't see that changing. in particular with regards to oilfield as well, right? So that market remained very, very robust. We've actually had success selling both TOFA and SOFA into that market, and we expect that to continue through 2023. Okay.

Excellent. Thank you.

I'll turn it over. And if I could add, this is Rich Spence, that the ability of our oilfield team to have already been able to receive approval of our alternative product in the oilfield segment has helped us to balance that TOFA demand that we have and the rise in impact that we have to meet the TOFA demand. So the timing was great. If we didn't have the alternative fatty acid, it would have been a bit more problematic for us.

And I want to be clear, too, Vince. We don't see volumes of CTO. You know, on the margin, it might come down a little bit this year. It all just depends on how the year plays out. It's really just the price of the CTO that's going to be an issue, right? So that's what we're working on. We do have, you know, our long-term agreements. We do buy in a third party. Our supply is secure for the year. It's just a function of what we're going to pay for it.

Okay. All right. No, that's helpful. Thank you.

Thank you. Our next question is from Chris Katch from Leap Capital. Please go ahead, Chris. Your line is now open.

Yeah, good morning. Thanks for the question. So on the mention your target leveraged by year end 23, I think it was two and a half terms from... Just curious what your assumption regarding buyback is based into that target, and just maybe more generally, how are you thinking about governing the buyback?

Okay, you were breaking up a little bit. I'll... answer and John chime in if I missed something there. But yeah, what we said in the release is back to that two and a half times area by year end and which is consistent with what we've said in the past. We were pretty aggressive on share repurchase in 2022. We continue to balance and our philosophy and actions are to balance debt pay down with share repurchase and expect to continue that in 2023.

Okay, fair enough. And then, John, you talked about the sequential trends in and around the destocking and industrial specialties and pavement. Curious if you could just talk about the sequential trends related to the COVID lockdowns in China. How is that affected? The businesses are reopening in China. Are you seeing that in terms of manifesting in demand? How has that progressed through the fourth quarter and thus far into the first quarter? Thank you.

Good question, Chris. I mean, you know, typically, and we talk about it a lot, right? I mean, typically in China, there's usually a large kind of pre-build and a lot of activity in the fourth quarter of China because they try and knock it out before Chinese New Year, right? That didn't happen this year. That's kind of what made it unusual because of their reopening strategy, right? So because they reopened so fast, a lot of the plants, not only OEMs, but also park people, so it influenced kind of the broader Asia region, really couldn't operate for periods of time because they were having to get their people through that sort of first wave and get their immunities up, right? So And then they roll right into Chinese New Year, right? So you have this kind of period that's not historically normal in China. But, you know, we expect and can see it. They're coming back, coming back to the races. We expect them to get back in. The reopening, I think, will be a positive. Their economy will recover. I think they're desperate to get back to normal. And we are going to benefit from that.

Got it. And just one quick follow-up in the PM segment. The pricing entitlement, or maybe not a good word, but the price increases that you referenced for calendar January 1, are those balanced in North America and China? Can you just provide any color on your approach, your strategic approach to pushing those price increases through? Thanks.

Chris, it's Ed. We typically try to have global pricing, and so it makes it a little easier for us to manage the business that way if we have South America, Brazil, Europe, China, all working on the same price levels. And so that's our target, and we're pretty close to achieving that this year. These are global customers, Chris, by and large.

Thank you.

Thank you. The next question comes from Ian Sofino from Oppenheimer. Please go ahead. Your line is now open.

I agree. Thank you very much.

Hi, Ian.

How are you? Good. On the auto side, you talked about a recovery in auto production. What are you looking at in sort of U.S. versus China versus kind of the rest of the world? And then, not that that's the biggest piece of it, but, you know, by market, where are you looking at it recovering and kind of what gives you confidence on that recovery? Thanks.

Yeah, Ian, this is Ed. You know, we're expecting, you know, there's a significant amount of, depending on the regions, right, there's a significant amount of pent-up demand in the U.S., You think of the average age of a vehicle in the U.S. is 12.2 years, and COVID has really pushed out that cycle. But I do think there's more positive trends going on as well in North America. You know, we've had six months in a row of increasing inventories in the U.S. To me, that indicates that supply chains are getting better. and recovering. Chip issues are also recovering. And so, you know, we're looking at a, you know, a good first half, but, you know, a lot of expectation for the back half of the year.

Okay, thanks. And then, you know, just on the TTO side, just one more question. How much of that is now market-based versus commodity-based? And how much is long-term contracts still

versus spot things? Under long-term contract, about 70% to 80% of our CTO is under long-term contractual agreements right now. It's hard to define market versus commodity-based. What I would say is there's a repricing going on from what would be traditional fuel purposes as the alternative into the new fuel biodiesel alternative, right? So it is changing the way everyone in the market is looking at the value of CTO. But again, as I've tried to allude to, it's an opportunity on a lot of levels, right? Because the biodiesel market is very, very large and going to only grow. And so that pricing relationship is not necessarily a bad thing over the long haul.

Okay, thank you very much.

The next question is from Daniel Rizzo from Jefferies. Please go ahead, Daniel. Your line is now open.

Hi, everyone. Thanks for taking my question. You mentioned that we talked a lot about CTO pricing and energy, but I was wondering if logistical and production costs are also continuing to trend higher.

Actually, I would argue that they're somewhat turning to a bait, right? I think certainly on the freight side of things, we're seeing some relief. I mean, I do like everyone. I mean, I think, you know, we have some personnel or manpower cost that, you know, continue to increase. But, you know, we're fortunate in that most of our production is not terribly manpower intensive, right? I mean, this stuff is pretty heavily automated. So it's not the driver that you would see. For us, Dan, the things that we pay most attention to really are natural gas and freight, right? And both of those things seem to be sitting in a pretty decent position right now.

Okay. And how should we think about working capital in 2023, just given kind of the puts and takes that we described here? I mean, is it going to continue to be somewhat of an outflow, or is it going to improve, or just any color?

So we do expect, again, you know, that's a good driver for our free cash flow, which is, I think, where you're headed. And we expect that to look good this year and free cash flow to be good this year. I will say Q1, you know, the last couple of years, Q1s have been a bit of an anomaly in that we have seen stronger cash inflows in Q1 than would be typical. And I would say what we expect this Q1 is for it to be more normal. So what I mean by that is, you know, our typical seasonal draw on cash in Q1 is what we would expect to see this Q1. And then the rest of the year, again, free cash flow momentum picking up. and working capital playing out over the course of the year.

If you go back, Dan, I mean, what is really probably the normalized cash flow for this company, you have to kind of set aside some of the distortions of COVID and what happened, right? Because Q2 and Q3 are such a big part of our profit drivers, what ends up happening is Q1 is typically light. Q2, you gain momentum over the course of the year, right? So then you pick up in Q2, you pick up in Q3, and then you really pick up in Q4, and then it kind of tapers off. And I think you're going to see that pattern sort of go back to what it – I mean, that's the way this company's sort of always been.

All right. Thank you very much.

Thank you. As a reminder, if you would like to ask a question, please press star followed by one on your telephone keypad now. Our next question comes from Mike Styson from Wells Fargo. Please go ahead. Your line is now open.

Hey, good morning. You know, the challenge of the fourth quarter, I think it's pretty well documented, you know, in terms of what a lot of the other companies are seeing. But when you think about the sequential improvement in the first quarter, a lot of companies have said, a little bit worse, a little bit better. How do you think, and I know you don't give quarterly guidance, but how should we think about the potential for improvement in EBITDA into the first quarter and how that weighs in for the rest of the year in terms of your EBITDA forecast?

My personal view, Mike, is that the first quarter may be a little softer from last year, right, just because when you're off, to January like it was. But I sit here and I look at February, and we're rolling into March, and I look at the order books. I mean, I can see the momentum building. So I think we'll have a pretty strong Q2, pretty strong Q3. We'll see what happens with Q4 with the last couple of years of calm. There'll be some surprise none of us are thinking about. But I do think we're going to get some sequential strength. That's just me sitting here today, right?

Right, right. Okay. And then, you know, the EBITDA margin for performance chemicals, clearly an anomaly, odds are. Can you remind us, you know, with Ozark and all the growth potential in the other businesses, where we should think that the margin can get to, maybe on a run rate toward year-end and maybe longer term?

Well, so as we talked about, Mike, first of all, you have to be very careful with fourth quarter margins. They typically are single digits. I'm not This is lower, this is on the lower end of what we've ever done. In fact, it may be our lowest, but I mean, typically they are single digits for performance chemicals in Q4. And that's just because of that seasonality factor that was exacerbated by some things, the destocking, there were other issues with plant runtimes, et cetera, et cetera, right? You know, I personally think that the margin this year for that business should be in the kind of high teens, right? Given the CTO pressure, I mean, I think being realistic, that's what we're trying to kind of aspire to, right? Long-term, as we've talked about, I mean, we think these margins need to stay kind of north of 20% to truly be a best-in-class company. But, you know, that's, I think, at least through 23, you know, given the CTO, that's what we're talking about here.

Okay. And then a follow-up on Ozark. How does the... backlog work for that business as you head into the summer and a lot of the other paint companies.

It's not paint, right? And you need to be careful with this. It's a road marking business, right? So it's very, very seasonal, just like our pavement business, right? The asphalt pavers, painters, stripers, what have you, You know, they really start buying in the first quarter of the year in advance of Q2, Q3, and depending on the market, may buy some in Q4, but it really falls off.

Okay. And do you expect to see some deflation that could maybe boost margins a little bit in that business as raw material costs, I think, have come down, generally speaking?

We don't necessarily see that.

Okay, great. Thank you.

Thank you. As a final reminder, if you would like to ask a question, please press star flow by one on your telephone keypad now. We have a follow-up question from John Tanrentone from CJS Securities. Please go ahead. Your line is now open.

Hi, guys. Thanks for taking my follow-up. Just wanted to... Sorry about that, John.

Somehow you got cut off, so we apologize.

No worries. Just wanted to follow up on the Euro regulation update. You mentioned that, you know, coming a little bit earlier than expected, which is great to hear. But I was wondering about the rest of the world following Europe. How quickly does that generally happen? And kind of what kind of volumes are you talking about? Because that's a pretty meaningful opportunity, just in the number of units and vehicles. So help me understand what the implications of that are, if that happens and rolls through.

Yeah, John, this is Ed. Usually you'll take probably lagging what Europe does, the rest of the world probably would be two to three years, four years behind that. Just because you've got some rather large countries such as India, Southeast Asia region as well, Russia is an example, Ukraine is an example that are using them as well. But You know, I think they all each have their own timeline and they have their own priorities of when they want to adopt a new regulation. So they would be adopting the European requirements, but I think there's a spread of timeframes between it'll happen post-Europe doing what they do. It'll be sort of gradually spread out over three or four years.

Got it. And do you have...

You're thinking of somewhere around 12 to 15 countries that follow the European requirements.

Okay, great. And do you have similar share in those markets that you do in Europe right now?

Yeah. I mean, what a lot of the – I mean, if you think of what's happening in India, India is still using a rather antiquated regulatory package. We are engaged with the Indian government to help them understand what the opportunities will be to move with not only what Europe does, but potentially with what the U.S. does. But it's a slow-moving change in some of these countries. Others are fast, but again, we do expect this to change to happen over time.

Okay, great. And then could you give us an update on your other alternative uses and markets for carbon and how those are developing?

Yeah, first and foremost would be, you know, activities with Nexion, and this is relative to making the silicon anode for battery electric vehicles. We are well engaged with Nexion and working hand-in-hand with each other to evaluate products that we're developing for Nexion to use. We're trying to continue to manufacture these. We've done some scale trials at some of our plants on them to make sure that we can meet the requirements and also the type of porosity that is needed for this silicon anode to work. I think we've probably got another year, two years of work before it becomes marketable. But, you know, we're there behind them and helping them as best as we can.

Got it. Thank you. And just one housekeeping question. Mary, do you have a projection for interest expense this year?

Yeah, we don't abide in interest expense guidance, but we've got Again, if you look at the debt on the balance sheet at year end and, you know, the spread, the spread on our debt is published in the K and the Q. It'll be the 10K will come out tonight. So you can think of, you know, right now I'd say in that 6% area would be the interest cost on the debt.

Okay, great. Thank you, guys.

Thank you. This concludes our Q&A session for today, so I'll hand over to John at NYPOVA for closing remarks.

That concludes our call. Thank you for your interest in longevity, and we'll talk with you again next quarter.

Thank you. Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect.