Ingevity Corporation Common Stock

Cool. We'll begin in approximately one minute time. Good morning or good afternoon, all, and welcome to the Ingevity second quarter 2023 earnings call and webcast. My name is Adam, and I'll be your operator for today. If you'd like to ask a question in the Q&A portion of today's call, you may do so by pressing star followed by one on your telephone keypad. I will now hand the floor over to John Naipava to begin. So, John, please go ahead when you are ready.

Thank you, Adam. Good morning, and welcome to Ingevity's second quarter 2023 earnings call. Early this morning, we posted a presentation on our investor site that you can use to follow today's discussions. 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 those projections as further described in our earnings release. Our agenda is on slide three. Our speakers today are John Fortson, our President and CEO, and Mary Hall, our CFO. Our business leads, Ed Woodcott, President of Performance Materials, and Rich White, President of Performance Chemicals, are available for questions and comments. Steve Hume, President of Advanced Polymer Technologies, is away on business travel, so John will field any APT questions. John will start us off with some highlights for the quarter. Mary will follow with a review of our consolidated financial performance and the business segment results for the second quarter. John will then provide an update on guidance, followed by closing comments. With that, over to you, John.

Thanks, John, and hello, everyone. On slide four, you can see our highlights for Q2. The team delivered double-digit revenue growth while maintaining mid-20s EBITDA margins, a great outcome in this environment. Three of our four business lines performed well. Performance materials had double-digit growth from last year, and we saw sequential growth as well. We were excited to see that Nexion, the company in which we invested $60 million last year, has announced an agreement to supply silicon anode material to Panasonic, one of the world's leading battery companies. Additionally, overnight, Nexion issued another press release announcing their intention to build a manufacturing plant in Korea, as well as a supply agreement with OCI. Nexion's silicon-based anode solution can increase the energy density of lithium-ion cells by up to 50%, increasing vehicle range and reducing charging time. This agreement validates the promise of Nexion's technology and its progress in development. We are continuing our joint development work with Nexion to include our activated carbon in their solution. This is a great step forward in our multi-pronged approach to finding alternative uses for our carbon. The Advanced Polymer Technologies team continues to manage that business efficiently and effectively, increasing margins into the 20s, even with sluggish economies in Europe and China, APT's two largest markets. While volumes were down in lower margin areas like footwear, We saw volume growth in the strategic areas we identified at our investor day. Bioplastics and automotive applications such as paint protective films. Increasing recognition for the sustainable nature of our technology is supporting growth in bioplastics. Just recently we added to our growing list of biodegradable certifications when our Kappa thermoplastic products were awarded the TUV Austria soil certification for providing biodegradable solutions for agricultural and horticultural applications. Results in the performance chemical segment reflect two very different business environments. Mary and I both will focus on walking you through what is transpiring. Our pavement technologies business delivered a record quarter. Even excluding the addition of Ozark road markings, our legacy pavement business had their highest sales quarter ever. The pavement team is executing the strategy we shared at Investor Day. The team is expanding our footprint globally and generating higher volumes in Europe and South America due to technology adoption. The UK is quickly converting to having one of the highest warmest mix adoption rates in the world, which means less energy use and lower emissions when using our flagship product evotherm. In Brazil, a Petrobras pavement plant is converting an entire refinery to include evotherm. This is a terrific development is only 12% of existing public roads in Brazil are made from asphalt today. And we are also adding new products and technologies to keep expanding our portfolio, both in warm mix and pavement recycling to meet the evolving needs of customers around the world. Our industrial specialties business and performance chemicals, however, had a challenging quarter and faces a tough environment, as we have discussed. Crude tall oil, or CTO, is the key raw material for this business, and the cost of CTO remains near record highs. When we refine CTO, we get equal parts tall oil fatty acid, or TOFA, and rosin. While TOFA demand remains solid, the headwinds we highlighted in our Q1 call remain, namely a teep at China recovery and continued restocking by customers. particularly in our rosin-based products such as adhesives. We are also seeing some adhesive customers shift to lower cost alternatives. As a result, we have slowed down plant run rates to manage the inventory build in rosin, which has negatively impacted plant throughput and the availability of TOFA for sale. If you have followed us for a while, you know this business is cyclical. The difference now is the step change in inflated CTO prices, which we expect to linger for some time. On an annual basis, we expect this to be a $200 million increase in the cost of CTO to what we paid last year. We knew that these costs would increase over the course of the year and had built that into our initial forecast and guidance. However, at that time, we anticipated we would be able to offset this cost pressure to a large extent through price increases as we expected in-market demand to continue to be strong, following the trend we saw into late last year. As we all now know, industrial in-market demand has weakened throughout this year, particularly in our rise in in-markets, but also in many other markets. As a result, performance in industrial specialties has deteriorated, and we are not seeing the offsetting strength in APT and performance materials that we anticipated. To mitigate these pressures, we initiated significant cost reduction actions across the company at the end of second quarter, which Mary will discuss in more detail. In the current economic environment, we will only recover roughly $100 million of the increased cost structure during the year. Our Alternate Fatty Asset, or AFA, transition is critical to offsetting higher CTO costs over the long term, and it continues full bore. We continue to expand production and expect to surpass historic CTO run rates at the CrossFit facility by this time next year. Our AFAs are currently being used in our existing products within pavement technologies and oilfield business lines. In fact, we are building new storage tanks to utilize more AFA in our pavement production. And we are making inroads with potential customers on products that are new to Ingevity. We are also investing in talent to support this transition, adding a lead commercial officer to help accelerate our entry into these new markets. Mary will provide more details on our quarterly performance, and I will cover the expected impact for the remainder of the year and beyond when we discuss our guidance later in the call. With that, I'll turn it over to Mary.

Thanks, John, and good morning, all. Please turn to slide five. Sales were up almost 15% as a result of stronger pricing across all segments, and higher volumes in the performance materials segment and pavement technologies business line, and the addition of Ozark, which we acquired in Q4 of last year. If Ozark were excluded, sales were still up versus prior year. These positives more than offset the impact of volume declines in the industrial specialties business line and the APT segment. Gross profit was up slightly year over year, but adjusted gross margin was down about 440 basis points due primarily to higher input costs, particularly CTO, and the impact on plant throughput of lower volumes, particularly in industrial specialties. STNA, excluding depreciation and amortization, improved to 9.5% of sales compared with 11.2% in the prior year. Adjusted EBITDA for the quarter was $120.7 million, flat to last year, with an adjusted EBITDA margin of 25.1%, a very solid result given the challenges we faced in the quarter. Diluted adjusted EPS of $1.41 is lower than prior year due primarily to higher interest expense and dna associated with the ozark acquisition and a higher effective income tax rate driven primarily by higher uk earnings and this year's increase in uk corporate tax rates from 19 to 25 percent turning to slide six you'll see that our free cash flow of 27 million dollars for the quarter was a bit lower than usual for Q2, reflecting significant working capital increases in the quarter, particularly for inventory of rosin-based products and CTO as demand for rosin-based products continued to be weak in the quarter, and in response, we dialed back processing of CTO. During the quarter, we repurchased about $59 million of shares bringing our year-to-date total to about $92 million. And while we continue to be opportunistic with share repurchases, we expect to focus on reducing leverage in the second half of the year while remaining disciplined in our capital allocation decisions. Also, as a result of West Rock's announcement in May that they will be closing the paper mill co-located with our Performance Chemicals North Charleston plant, We expect to incur some additional cash costs and expenses as we transition previously West Rock managed shared services, such as utilities, to our sole use. For this year, we expect those costs to be between $15 and $20 million, most of which will be incurred in the second half. We're continuing to evaluate the ongoing impact on our operating costs. As John mentioned in his comments, we are taking actions to reduce costs across the company to better align our cost structure with the business environment, and we expect to see annualized savings from the actions we have already taken to be approximately $35 million with $20 million expected to be realized in 2023. These actions include headcount reductions, renegotiating supply contracts, OSBT, Karen Hollweg, And a tight rein on discretionary spending, including travel if business trends do not improve in the second half of the year, we are prepared to take further action. OSBT, Karen Hollweg, Turning to performance chemicals on slide seven as john said it was a tale of two business lines pavement had a strong quarter a big piece of the year over year increase in sales is the addition of ozark. but our legacy pavement business alone posted a record quarter, driven by growth not only in the US, but also in Europe and South America. This strong demand for our sustainable products gave the team pricing power across all regions. Industrial specialty volume was down in the quarter, primarily as a result of macroeconomic trends seen throughout the industry, namely continued customer destocking, weak demand for rosin-based products in particular, and the slower China recovery. We attribute roughly 20% of the drop in volume to customers moving to lower-priced substitutes such as hydrocarbons. As John said, due to the higher cost of CTO, we are on track to spend roughly $200 million more on CTO this year versus last year. The team has done a good job of capturing price, but with market weakness continuing, unlike last year when we covered the cost inflation, we now expect to cover only about half of this year's inflated CTO cost through increased price. We want to emphasize that the major headwind for industrial specialties is on the rosin side, not TOFA. Rosin end markets are more susceptible to economic slowdowns, And those customers are more price sensitive since there are various substitute products available, as we're seeing with our packaging customers. Demand for TOFA is still strong. However, we slowed down the refining of CTO in order to reduce the amount of rosin inventory we are building and thus had less TOFA available for sale. As a reminder, the transition to non-CTO feedstocks, what we call our AFA initiative, addresses this challenge since other oleo feedstocks do not produce rosin. Turning to slide eight, sales for advanced polymer technologies were flat year over year. However, the team did a great job increasing prices and improving profitability, more than tripling EBITDA year over year. Volumes in North America were up for the quarter, but overall volumes were down, primarily due to customers in Asia being reluctant to restock as a result of the uncertain demand outlook in the region and Europe's ongoing industrial slowdown. Asia and Europe represent roughly 75% of APT sales. Therefore, the pace of those regions' recoveries will impact the second half performance for this segment. Our profit improvement initiatives, including pricing actions and product mix management, along with lower input costs, more than offset the impact of lower volumes to generate 21.8% EBITDA margins. Product mix benefited from increased demand in bioplastics and automotive applications, particularly paint protective film, two key strategic growth markets. that we discussed at Investor Day in May. We're seeing increased adoption of our CAPA products as customers shift toward materials that have a more sustainable footprint. Our new product and business development efforts are accelerating and we are seeing tangible results with new customer additions, particularly in areas that support our growth strategy, such as bioplastics, apparel, and auto. On slide nine, you'll find results for performance materials. We're pleased to see the continued volume growth in this segment, not only year over year, but also sequentially. The global auto industry appears to be improving, although more slowly than we had expected, and results vary by region. North America was our strongest region for the quarter, and China was up from last year's extended shutdowns, while Europe was flat. We're cautiously optimistic North America auto production rates will remain steady, but the outlook for Asia and Europe is less clear. Margins were down slightly versus last year, primarily due to a higher operating cost as we reduced plant run rates to manage inventory. In summary, most of our business lines posted strong results for the quarter, despite a cautious economic climate and a sluggish recovery in China. Our industrial specialties business faces unique challenges as we transition away from CTO as a sole feedstock at the same time that a key product, rosin, is undergoing a cyclical downturn. We've implemented cost reduction actions to realign our cost structure and we'll take further actions as needed. We remain focused on ramping up our AFA output in sales, while maintaining strict cost discipline. And now I'll turn the call back over to you, John, for an update on guidance and closing comments.

Thanks, Mary. As you saw in our release, we are reducing our guidance for the remainder of the year. When we provided our original full year guidance, we knew that elevated CTO prices would negatively impact the business. But we expected a more robust recovery in China and a stabilizing Europe. that would allow growth in our pavement technology business, performance materials, and APT to more than offset the shortfall. When we reported our Q1 results in May, it was clear the recovery in China was not going as planned, and Europe was facing an industrial slowdown. We were one of the first companies to say this. And remember, China, along with the rest of Asia and Europe, represent roughly half of PM sales and nearly three-quarters of APT sales. Therefore, when we didn't see the boost from those regions, we realized we would not be able to offset higher CTO prices, and we reduced our guidance. Which brings us to where we are now. We still have not seen significant improvement in China or Europe. General market weakness continues to suppress volumes in our industrial specialties business, and the historically high CTO prices we had expected to moderate have remained elevated. We don't expect to see relief from these prices until 2024, which is why we are reducing guidance for the remainder of the year. We are taking actions to mitigate our CTO exposure longer term, consistent with the strategy that we laid out for you at our investor day. There are four variables we manage in the performance chemical segment, two of which are in our direct control. Our industrial end markets will improve as the economy improves. CTO costs should come down as the biofuels market matures and rationalizes, Our AFA strategy will reduce our risk exposure and we will control our cost structure to ensure what we produce we can sell profitably. The last two we control and we are aggressively taking actions. Three of our businesses are performing well and will contribute to our overall performance. Auto production is improving, perhaps not at the rate we would like, and certainly not across all regions evenly, but it is improving. Plus, the adoption of hybrids both here and in China seems to be gaining steam, which is good for the PM segment. Our work on alternative carbon applications is progressing. The pavement team continues to both expand their global footprint and to enhance the growth we will see from government infrastructure funding in the United States. Greater adoption of biodegradable materials and consumer packaging and apparel is a secular tailwind for APT that should provide significant increased demand. The AFA transition directly addresses the biggest headwind we have, which is relying on a single raw material CTO to support a business segment. As we continue to ramp up AFA capacity, the impact of higher CTO prices will abate, and we will have the flexibility to pivot to different raw materials to optimize cost with the added benefit of not producing rosin. Finally, We will continue to constantly evaluate all options and adjust our business and cost structure to reflect the changes in our markets. By levering all these opportunities, we will cover the gap from the increase in CTO costs. We remain confident that we will emerge a stronger, best-in-class performance chemical company that sustainably purifies, protects, and enhances the world around us. With that, I'll turn it over for questions.

As a reminder, if you'd like to ask a question today, please press star followed by one on your telephone keypad to enter the queue. When preparing to ask your question, please ensure your headset is fully plugged in and unmuted locally. Our first question today comes from Vincent Anderson from Stiefel. Vincent, your line is open. Please go ahead.

Yeah, thanks, and good morning. So let's just kind of start with CTO. And here's what I think I know about CTO markets right now. So spot, as best we can tell, is down. There's no biofuel capacity that emerged out of the blue. U.S. exports here to date through May are down 10%, generally falling for the last two years. Export prices there seem to have also peaked in March. So we don't have a lot to go off of, but the only place that we're seeing prices stay elevated are the prices you pay and export prices to Sweden and Finland, which is a little different given Craton has assets there. So I know your contracts are confidential, but is there anything you can unpack for us as to why we have this apparent disconnect and what gives you confidence that this won't be a persistent risk?

Yeah, so I'll kick it off. And if you want to add anything, Rich, please do. But listen, we have tried to ring fence for you, Vincent, the impact, right? So we've given you a number that hopefully will help. navigate the market or let everyone understand exactly what the issue is for us, right, with extreme transparency. The problem that you're running into is this is not an efficient market. So the data that you see, whether it's Argus or elsewhere, does not necessarily reflect exactly what's going on, because as you've identified, they sometimes include certain exports, don't include other exports. They sometimes include the biofuels market, sometimes don't include the biofuels market. They do not, and just to be candid, we didn't even contribute our data to Argus until recently, right? So that is not, unfortunately, an efficient or effective way to look at it. Now, I will tell you that our pricing will tend to lag probably what you see By anywhere from three to six months right but that works kind of against us when prices are coming down and works for us when prices are coming up right but even that. You have to be careful with right so we're aware of this problem from the market, because I know everyone wants to be able to sort of forward predict us so we're trying to give you. The scope of the issue for this year right, I mean it's a $200 million hole, for lack of a better term that we were able to claw back or recover about 100 million. So far we're going to do the best we can to continue those efforts, but that's what we're up against longer term. I do think CTO prices will come down, I think that the market got ahead of itself. on speculation for European biofuel inputs. The European biofuel market has not materialized at the rate that people were anticipating, and we went into a period of economic weakness. So you will see some CTO relief. But I cannot tell you exactly what that level will come to. We have an idea of where it should land. But again, this is not a totally efficient market. But I hope that gives you some more color, Vince.

Yeah, no, that's helpful and very fair points. Turning over to the demand side, you know, on the margin side of the equation, could you give us a rough just order of magnitude around what your mix impact looks like when you lose a rosin ester sale into something like an adhesive and have to instead, you know, drum that product and send it to the export spot market instead?

Well, our merchant rosin sales – this is Rich, Vince. Our merchant rosin sales have, for the most part, abated, which is why we're building so much rosin inventory at the moment. But on the order of a magnitude, our rosin sales into the merchant market are significantly less on the order of 50% less than what we're doing in the derivatized market today. The merchant rosin is pricing exactly that. And if I could add, compared to the alternatives, whether it's hydrocarbons or gum rosin, our merchant rosin pricing to date has been about 15% higher than the gum rosin area and about 30% higher than the hydrocarbon market to date.

Okay, so we're kind of past the negative mix impact of losing your higher value derivatives and we're into really more just absolute volume demand when we think about the way we demand in the back half of the year. Yeah. That's correct.

I think that's fair. Yeah.

Okay. And then just a really quick one, and I'll turn it over. But do you have to requalify any of your pavement products based on a feedstock change, like moving from TOFA to AFA?

Yes. Primarily for North America, not so much externally. Not outside of the U.S., but yes.

Okay. And did I understand correctly in your prepared remarks that you've already begun that process in some respect?

We have. Yes, we have. It just takes time. Okay.

Yeah, no, of course. All right. Thank you. That's helpful. I'll hop back into queue.

The next question is from John McNulty from BMO Capital Markets. John, your line is open. Please go ahead.

Yeah, good morning. Thanks for taking my questions. So the magnitude of the cut for the full year is admittedly pretty chunky, but it looks like there's a lot of unpack here so i guess can you can you kind of bucket it out for us how much is tied to the incremental costs around the west rock transition if you will um how much is tied to actual cto costs and then how much of it's tied to you just running at lower operating rates and kind of having to absorb that that fixed cost absorption i guess can you can you help us to maybe bucket these these kind of bigger categories

So I'll start. The West Rock impact that I mentioned in my remarks, it really goes to cash costs and expenses. We will be kind of, I think of it as carving those out from the GAAP results. So going forward, that impact would be excluded in our adjusted numbers. But it's still cash. So if you note in the release or in the deck that we provided, we also did reduce our guidance with respect to free cash flow coming down and a lot of that, particularly second half of the year, is related to the cash costs associated with the West Rock transition. With respect to the EBITDA decline, that's more Again, CTO-related and the inability, both the inability to push enough price to recover those costs because their end markets are soft, but also the general economic slowdown, which is not permitting a robust recovery in PM or APT to offset or mitigate the costs in SPAC.

Right. I mean, John, it's difficult to separate CTO... versus the end markets, right? I mean, you have seen us go through cycles before where we have built rosin. The last one, you know, really kind of occurred in 18, right? The reason we're in this situation with the orders of magnitude is this, you know, large hit to CTO, right? Which is why we're trying to quantify for you the number so you can understand what the ramification is, right? You know, when you look at the performance chemical segment writ large, you know, you can do the math on the margins of the pavement tech piece of that and come to an annual number because it's really spread out mostly over, you know, Q2 and Q3, as you know. And then you can kind of impute what the ramifications are for industrial specialties. It's a large number. I mean, they're absorbing $200 million of incremental cost, of which we've been able to claw across the company, about 100 back. So, you know, would a better economic environment have helped that? Sure. Had we stayed? I mean, it's interesting because we've done a lot of internal analysis. Had the market environment stayed as it was last year, we would have been able to bear this CTO inflation. And I say that kind of across all of our businesses, right? Not just InSpec, but we would have been able to absorb it. It's just the economic environment is weakened to the point where this is the, you know, this is the put and take of those two, right?

Okay. Okay. No, that's helpful. And I guess when you think about the reduction in the guide, because, look, CTO was high before, and it seems like from a contractual side, you probably had a rough idea how those costs were going to play out this year. So is it

sure at least when you gave kind of the prior guide so i i guess how should we think about the incremental thing that changed that's causing you to pull down the guide is it just that china is that much weaker and the markets are weaker john i mean i don't i i want to be very clear because i want everybody to understand right i mean the cto it is true and i think sometimes people have missed that the cost of our cto has been gradually escalating over the course of the year. We talked about this at Investor Day, but I don't know. Q2 is more expensive than Q1. Q3 is going to be more expensive than Q2. Q4 is going to be more expensive than Q3. It will level out going into 24. At that point, we will be more what I would call at market, meaning that we will you know, to the extent we get some relief in CTO, we're going to really feel it, right? It'll help us quite dramatically next year. But what's causing the issue in the back part of the year is that the markets that we sell into have really, really weakened with the exception of pavement technologies and oil fields. In particular, these are rosin markets. It's very reminiscent to me of where we were back in 18, where we are having to basically slow down rates because we cannot move the rosin. The rosin is not selling. That's what's happening. We raised prices last year. We raised prices last year in the industrial specialty businesses almost a quarter of a billion, actually over a quarter of a billion dollars, right? So we were in position to absorb this, right? The challenge is that people are not buying, right? So hopefully that's helpful.

Yeah, no, I think it is. But just to make sure I've got this right, is the weakness in the rosin market because the actual end customer, end product demand is soft, or is it just, look, they can't handle the price, and so they're just giving up on it and going to something else?

They're not buying, John. I mean, obviously, price moves up and down, and we will adjust price, and we can adjust price, and we obviously have a higher cost structure. But ultimately, they're not buying, and they have the ability to substitute into lower cost alternatives.

And I did mention we estimate approximately 20%. of our customers have shifted to lower cost alternatives that may be rich. If you want to add some color.

If I could, John, when we look at the overall demand in industrial specialties, particularly on the rosin products, and you're talking about adhesives, rubber, paper sizing, we know many mills are shutting down, and printing inks. But when we look at the demand that we've seen this year, Mary's correct, 20% is related to reformulation to hydrocarbons or some other type of gum rosin, but 80%, 40% was related to destocking and another 40% was related to demand destruction. And that's pretty much what we've seen across the entirety of our rosin offering. Got it. Okay.

That's helpful. Thanks for the call.

The next question comes from John from CGS Securities. John, your line is open. Please go ahead.

Hi, good morning. Thanks for taking my questions. Mary, just to jump on the back of one of the prior questions, you guys explained that the CTO and Roslyn did pretty well. What is the reduction in the guidance in the PM and the APT businesses? How much less is that expected to contribute this year compared to what you had thought maybe three months ago?

Yeah, I think versus our last call, probably not too much change. But I think certainly when we set the initial guidance, we expected a more robust recovery in China. And again, that the solid underlying economic trends that we had seen heading into the year would continue. While we are seeing, while we did see volume increases in PM, we're certainly not seeing the robust recovery in China that we had expected. And it really is a tale of North America holding up and looking pretty good. But Asia, you know, sluggish, and Europe, frankly, struggling. And on the APT front, Again, remember, 75% of their products are sold into Asia and into Europe. So the lack of a rebound in China and Europe showing essentially no pickup at all have reduced our expectations for that business as well. Not, you know, certainly not to the extent of industrial specialties. but versus what we had expected.

But that having been said, Don, I mean, the growth rates for those businesses when you look at them on an annualized basis are still pretty robust and healthy compared to other segments or other businesses, right, that we're looking at. I mean, whether you look at TM or you look at APT or you look at pavement, you know, they're all growing pretty healthily in this environment, right? Not so much, you know, PM, not so much on the revenue side, but certainly on the profitability side. APT has really done a great job of moving their margins up. Again, not so much on the revenue, but more on the profit side from where they were last year. And payments have been a great year. So, you know, to Mary's point, you know, it's certainly down from where we were last year, you know, at the start of the year, our expectations. But from our last guide, I wouldn't say they've moved a whole lot. Maybe a little bit, but not a lot.

Understood. Thank you. And then you started the call off with a really nice bright point, which is the Nexion agreements to Panasonic and Korea. Can you help us understand kind of the quantity of commercial sales that Nexion is expecting to be doing and kind of when you expect to be in the supply chain supplying that material and if that's any change from your private expectations?

So look, we're very encouraged. We are big fans of Nexion, right? We are really excited by their success, and it's validating a lot of, you know, the work that we did as we analyzed and assessed, you know, our opportunities in that market. You know, the reality is one plant in our view in Korea is just the start, right? I mean, this will involve thousands and thousands of tons of product as they ramp this up and move beyond just this initial contract that they've started with Panasonic. What they've done is what a lot of startup companies do. They've got a good contract. They're going to build in the region. They're tying to a strategic partner. They're doing all the right things to get in position to be successful and then grow this business. And we anticipate being a part of that. I don't want to, as we talked about in Investor Day, nothing's changed. We don't want to get ahead of ourselves because we're going to be a part of that, but our view is that it's really something that we will play a bigger role in in the middle of the decade and beyond. That's really what we want. We have lots of great opportunity in our core businesses. Our, our position and our opportunity where we're focused is as they generate next generation or as they develop next generation technologies. I don't know if you want to expand on that.

Yeah, John, I would say that next year on put a press release out in the last 24 hours and that should be able to answer a fair amount of your questions on on their pathway, particularly in the near term. Yes, right.

Okay, great. Thank you. And then just last quick one from me. How is the AFA transition progressing from a demand perspective? Are you still in the capacity to bring online kind of where you expect to be by the end of the year there? Yeah, and look, nothing has changed.

But, John, I think it's an important point, right? Because, you know, while we've got these three businesses are doing well, we've got one business that has some secular or structural changes to it. And afa is a critical part of our strategy to go forward cto prices you know the economy will improve we talked about that you know we have those four variables cto prices will abate they will come down but over the long haul the right answer is to offer our customers fatty acids that solve for their technology needs right and the advantage of AFA is that it is an alternate more reasonably sourced raw materials and it does not produce rosin, right? So we are very focused on it. It remains on track. We mentioned in our prepared comments that the volumes we anticipate producing out across it next year will equal the CTO volumes that we've traditionally run through that plant. We continue to work and our customers are being receptive to the reformulations necessary. As I mentioned earlier, it just takes time. We cannot, there are processes and testing, et cetera, that we have to go through. But ironically, high CTO prices, you know, help make that sale to the customer because they need an alternate, right? And so we remain on track and very focused on this.

Okay, great. Thanks, guys.

The next question is from Ian Zafino from Oppenheimer. Ian, your line is open. Please go ahead.

Hi, Greg. Thank you very much. You know, again, on this AFA, I guess as CTO prices continually think they are, how much of your production do you think you'll actually shift to AFA versus CTO? And how long will that actually take? Thanks.

Well, again, so if you kind of think backwards and back of the envelope, we've got a three-plant network, right? One of those plants is going to move to solely – well, it is moved to running solely AFA, and we've said that next year we'll be producing volumes equivalent to what we have traditionally run. So that gives you a sense of the volumes that we're talking about. Over the long haul, as we mentioned at Investor Day, We have the ability to actually double volumes in the segment if, in fact, we're able to produce all of our CTO and all of our AFA. I don't know how that will play out, but our goal is to affect the transition and offer substitutes so that our customers can go, depending on the cost position of CTO, can move between those products and then also to expand and enter new markets down the road, right? But right now, our focus clearly is on substitution and, you know, while we ramp up new markets.

Okay. And then as far as the questions about or the comments about being able to, you know, transition or toggle back and forth between different AFA, CTO, You know, how quickly are you actually able to do that and how flexible would you be, let's say, if CTO prices come back down?

Listen, we've committed to roughly $70 million of revenue this year coming from AFAs. That's on track. We've not, you know, laid out yet what our expectations are for next year. You can make some assumptions based on the volume comments that we made earlier, right? But it is our intention over the next 24 months to have that plant fully moving on AFA offering alternatives.

Okay, thank you very much.

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

Good morning. Thanks for taking my question. Just to follow up on AFA, is there anything in the production process or is there an input that could cause the price of producing AFA prices to kind of spike similar to, I mean, a different product, but something similar to what we saw with CTO and with Rosins and things like that?

Well, to answer your question, look, this is the reason why we want to use multiple feedstocks, right? because of the biofuel market, and it's not only affecting CTO, it's affecting a lot of the oleochems, right, particularly those that are non-food-based, right, or those that don't go into the food chain. And they, you know, people who follow those commodities, who may be on the call, know that they kind of ran up in 21, 22, and then ran down. They are typically more cyclical because they're tied to much broader sort of macroeconomic factors. All of these are being disrupted to some point, to some extent by the biofuel market. The biofuel market gets regulated as the, because the European regulators really look at, you know, how much biofuel they put in and out of their mix based on the price that the end consumers in Europe might pay, right? So those are going to, that's going to move around too. It will eventually, we think over the next two years or so, stabilize out as that market matures and all the feedstocks sort of come into place that's one of the reasons we think cto will come down from pricing perspective right if you look at it it's if they're out ahead of that market it will come down but we want what we like about multiple feedstocks is we can move between these as they you see different spikes and different Soy is a great example. Soy ran up, now it's ran down. Soy is very attractive right now. Canola ran up, ran down. It's very attractive. So we want that flexibility in our feedstocks.

And let me tag on to that. So soy, canola, for example, Dan, much, much bigger, more liquid markets than CTO. And unlike CTO, you know, remember, CTO... only made by paper mills. So their sales of CTO are episodic, if you will. You know, they're putting chunks into the market. So we're purchasing when they have product available, et cetera. Very different dynamic in a soy canola type of market, again, because of the size, the liquidity of the market. So our ability to control the timing of our purchases and perhaps hedge our purchases because, again, there are cost curves, they're well established, the size of the market, et cetera, puts that purchasing dynamic in a very different framework than what we now have with CTO.

That's helpful. That's very helpful. Thank you. And then is there any way, I mean, are you thinking about, as you look at cutting costs, are you looking at any way to, I don't know, optimize your footprint, I don't know, reduce the plant or close the plant near the end of the month?

Let me put it this way, Dan. All options are on the table, right? As you know, there's lots of different levers that can be played when you're optimizing a footprint, but all options are on the table.

Okay. All right. Thank you.

As a reminder, that's star one to ask a question today. The next question comes from Mike Sizer from Wells Fargo. Mike, your line is open. Please go ahead.

Hey, good morning. So the $100 million gap that you have this year from CTL, how do you get that back next year? Is it just simply you're going to get more pricing, I assume, this year that flows into next year? Or do you need demand to sort of come back and then you get the pricing through?

I think of the four levers, Mike, that we talked about, right? Our intention is to try and get it back through continued growth in our other businesses and through continued escalation of AFA sales and through reduced cost structure. Certainly improvement in market conditions or reduced CTO pricing would help us in that. So we have to look at all of those influences or market factors to try and manage this, we control two of them, right? So we will do what we can to control, but obviously to the extent the market does improve or CTO pricing improves, that's going to make our job easier.

And certainly as China, again, John's comment about industrial recovery, certainly China will pick up at some point. Certainly I believe the economy will begin to pick up better than it has to date. So again, you know, even rosin, rosin markets have shown a history of taking a deep, digging a deep hole and then coming back quickly when they do turn. What John has discussed, though, is we're not waiting for all those things to happen. We believe they will, but we don't control the timing of those market dynamics. So the actions that we're taking are to better position us so that in those products and feedstocks where we're at the mercy of, you know, the markets or, you know, certain very tightly controlled feedstocks that we're taking actions to put ourselves in a better position long term.

No, I understand. But if you think about the price that these products are at now, if you do raise the price further, is that a problem relative to maybe an olefin-based product that you're kind of sort of tapped out in your ability to raise the price? Or is there, if demand comes back, you can get the price? Yeah, okay. And then, well, if demand comes back,

If demand comes back, Mike, we would expect to be able to at least hold prices. Now, with demand where it is, even with some pricing concessions, certain customers are able to find lower cost alternatives.

Well, and we believe that as we make this move, we will be able to offer lower priced alternatives while maintaining slash improving our profitability because Some of these other raw materials are not nearly as expensive on a relative basis to crude tall oil today.

Got it. Got it. Okay. So if I kept performance materials sort of my outlook similar to last quarter, and I think a lot of companies have sort of felt pretty good about the auto outlooks for the second half of the year, and then sounds like APT will be maybe – maybe slightly lower, it kind of implies performance chemicals takes a pretty big dip, third quarter, fourth quarter. If you think about it, Mike, it's mostly fourth quarter. Is that the right way to think about it?

Yeah, if you think about it, it's mostly fourth quarter, right? I mean, you think about performance chemicals, you've got this high-profit, high-performing business that's really generating in Q2, Q3, right? And those businesses really abate and Q1 and Q4 right so when you know we don't we don't provide quarterly guidance, but when you're calendarizing it, you need to understand that Q3. We will continue to benefit from you know asphalt and pavement sales, but in Q4 those sales don't exist so Q4 performance chemicals is going to take a hit be challenged.

Okay. And then when we think about 24 for performance chemicals, we should get a portion of that $100 million back based on what you're doing on the things within your control. And if CTO comes down, you could actually get the other remaining to be a plus $100 million next year.

It's possible. I mean, it just depends on, I mean, my own view, Mike, is I don't believe the CTO, I don't believe we're going to get all 200 million of that CTO back. I just want to be completely clear to everyone, right? I mean, but if the gap is 100 million, right, what do we do? Well, we've got those four things at work. How much cost can we take out, right? How much AFA can we sell, right? What kind of market improvement do we get? Right? So, I mean, we actually feel like 24, while, you know, InSpec's going to be challenged, we've got levers to, right? But it's a little early for me to gauge where the market and the CTO is at. What we're working on are the other two, right? Because those we control.

Right.

Okay. Great. Thank you. We have a follow-up from Vincent Anderson from Stiefel. Vincent, please go ahead. Your line is open.

Yeah, thanks. So, John, I just wanted to go back and clarify some of the AFA comments. Is your target volume for next year at CrossFit, you know, basically equivalent to the full Phase I that you outlined, or are you implying more like, you know, two-thirds of that when you draw that CTO comparison?

So the way I would think about it, Vincent, is we should be, by this time next year, so the middle of the year, running at full run rates, which would be about 125,000 tons, give or take, right? So when you weigh that over the course of the year, it won't be the full 125, right? Because we'll be ramping up in the first half of the year, right? We may do better than that, but that's where we're sitting here right now, right?

Okay. And then, you know, as much as you're willing to comment on it, would that alone be enough to cover fixed costs at the plant and maybe even potentially contribute positive standalone margins?

Well, the goal, as you know, Vincent, the more we run it, the more we cover our fixed costs, right? Which is why we want that thing running as quickly as possible at those run rates, right? I just think realistically, when you think about product certifications and all the complexities we talked about, it just takes time. To the extent we're able to find a new market customer that doesn't need those certifications, we can accelerate that and we've hired a person to help us do that. To the extent we can continue to accelerate customer certifications, we can accelerate that. That's our planning today.

Okay. And then just last one promise. You know, there's still a lot of actually dislocation even within the vegetable oil and animal fat feedstock markets right now because a lot of this new biodiesel capacity isn't really set up to take crude-grade products. What is your ability to accept lower-grade products, whether it's just base crude, vegetable oils, or even some of the dirtier stuff that you don't even really get pricing on?

Yeah, we have, this is Rich. Yes, we have the ability to take some of the lower grade stuff in our processes and that, and also are already sourcing some of that lower grade material today in our process that we're, they're using at the CrossFit facility right now.

Excellent. All right. Thank you. That's all for me.

We have no further questions. Go back to John.

Yeah, before you go, John, I've just been reflecting a little bit, Mike Sisson, on your thinking through the quarters and how the rest of the year will unfold because, like I said, we don't guide quarters, but I do think it's important to understand the timing and the sequence. When you think about our new guide, right, or this revised guidance, and you think about the earnings power that's coming out of it, I mean, Q3 we talked about, right? You know, we got all those businesses Firing right PT PM a PT right and in the fourth quarter you got three of the four basic well you got two of the two of the four right basically you've got PM and a PT so our guide really is all about. PM a PT and pavement continuing the trajectory that they're on, but we are de risking from a guidance perspective what's happened with inspect right so. When you think about this, I mean, you are correct. In spec, in Q3, and particularly in Q4 when you'll see it, the performance chemical segment is going to underperform, but we're trying to de-risk that from the guidance, right? So going forward, the upside and the sort of downside, but we think hopefully more upside, is really tied to those three core businesses, right?

That's it.

Thank you, John.

Night, Popper. All right. Well, thanks, everyone. That concludes our call. We appreciate your interest and longevity, and we'll talk with you again next quarter.

This concludes today's call. Thank you very much for your attendance. You may now disconnect your lines.