Ingevity Corp (NGVT) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Ingevity third quarter earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. (Operator Instructions). As a reminder this conference is being recorded. I would now like to turn the conference over to our host, Dan Gallagher. Please go ahead, sir.

Thank you Roxanne. Good morning everyone. Welcome to Ingevity's third quarter earnings conference call. Earlier this morning, we posted a presentation under the Investor section of our website that we will be speaking to on today's call. If you haven't already done so, I would encourage you to download the file in order to follow along. You can find it by visiting IR.Ingevity.com under Presentations. On slide two of that deck, you'll see our disclaimer that today's earnings call may contain forward-looking statements. Relevant factors that could cause actual results to differ materially in these forward-looking statements are contained in our earnings release, and in our SEC filings including our Form 10 and our most recent 10-Q. Ingevity undertakes no obligation to publicly relation any revision to these projections and forward-looking statements made during the call, or to update them to reflect events and circumstances occurring after the call.

Throughout this call, we may refer to non-GAAP financial matters, which are intended to supplement not substitute for our comparable GAAP measures. Definitions of these non-GAAP financial measures and reconciliations to comparable GAAP financial measures are included in our earnings release, and can be found on the Investor Relations section of our website. For purposes of this earnings call, 2016 non-GAAP financial measures are compared to the equivalent to 2015 pro forma non-GAAP measures. Our agenda is on slide three. With me today are Michael Wilson, President and CEO, and John Fortson, Executive Vice President and CFO. As you can see by our agenda on slide three, Michael will provide some commentary on the highlights of the quarter, and will review performance of our two segments. He will also provide commentary on the state of Pine Chemicals industry. John will discuss our current financial status, and then Michael will make a few brief closing remarks. At that point we'll open up the phone lines for questions. Joining Michael and John during the Q&A portion of the call will be Ed Rose, President of Performance Chemicals, and Ed Woodcock, President of Performance Materials. And with that, I would like to turn it over to Michael.

Thanks Dan. Good morning everyone. Thank you for joining us this morning and your interest in Ingevity. If you turn to slide four, I will walk you through some highlights of the quarter. In the third quarter, our results were strong and in line with our expectations. Despite slightly lower sales, we achieved adjusted EBITDA that was more than 5% higher than the prior year quarter, our adjusted EBITDA at $59.6 million, up $3 million versus the prior year, translated to diluted adjusted earnings per share of $0.64, our third quarter adjusted EBITDA margin of 23.7% was up 160 basis points from the prior year quarter margin of 22.1%. In addition to the strength and diversity of our business, a key contributor to our performance continues to be our ability to reduce costs across the Company.

Our company-wide cost reduction and productivity initiatives remain on track to deliver $25 million to $30 million in cost savings this year. As part of our continued evaluation of our cost structure, we decided to close our Palmeira, Brazil crude tall oil or CTO refinery, which triggered a $32.2 million noncash restructuring charge in the quarter. This charge in combination with other restructuring and separation costs, resulted in a GAAP net loss of $4.8 million in the quarter. I will discuss the rationale for the Palmeira closure later in the call, but suffice to say, excluding the adjustments our performance in the quarter was strong. Our primary driver of our third quarter results was outstanding performance in our Performance Materials segment. Turning to slide five, you'll see that segment sales were $79.3 million, up $15.4 million, or 24% versus the third quarter of 2015.

Segment EBITDA of $32.3 million was up $9.9 million, or 44% versus the prior year. This translated to a 40.7% adjusted EBITDA margin, which is up 560 basis points from a year ago. Performance Materials again set quarterly records for both sales and adjusted EBITDA. Driven primarily by volume growth due to increasingly stringent regulations for automotive gasoline vapor emissions control. To meet new regulatory requirements, automakers are increasing the content of our activated carbon products on vehicles. The volume growth we are experiencing is expected, and consistent with the roll out of the 2017 model year vehicles being sold in the United States and Canada. As we indicated last quarter, we've seen a substantial increase in revenue for our products that are used to comply with the harmonized US Tier 3 and California Lev 3 regulations. These regulations are phasing in now across the US and Canada, with minimum vehicle phase-in requirement of 40% for 2017 model year vehicles. The regulations require 60% compliance of 2018 year model vehicles, 80% by 2020, and 100% by 2022. Another contributing trend, albeit to a lesser degree is the move towards larger vehicles aided by lower gas prices. In North America production of light trucks which utilized more of our material are up 7% through nine months on a year-over-year basis while production of cars are down 5%.

Overall, vehicle sales in the US and Canada are up a mere 0.7 of a percent year-to-date. However, when you combine the increasingly stringent regulations which drive the use of our propriety honeycombed products in greater quantity, with the ongoing trend toward larger vehicles, it enables our business to grow far in excess of vehicle demand.

Our performance materials manufacturing operations ran well in the quarter. We successfully completed a significant planned maintenance outage at our Wickliffe, Kentucky facility on time and on budget. Our Covington, Virginia, activated carbon facility is currently down for a scheduled outage. Also of note as planned, we made our first shipment of qualified automotive grade carbon from our new Zhuhai, China facility during the quarter. In the fourth-quarter, we are focused on ramping up production there. The major investment with made in capacity in China is consistent with our expectation for long-term demand growth globally.

In China, new regulations governing gasoline vapor emissions control are continuing to advance. On October 3rd, China published it's China 6 regulation to the world trade organization, which now has a 60-day comment period on the regulations. The China 6 regulation would be a national regulation calling for the use of on board refueling vapor recovery, or ORVR systems, similar to US Tier 2 regulations. This standard would require both larger quantities and more highly engineered activated carbon products than current regulations. Consistent with our expectation the Chinese government published a schedule targeting 100% compliance by July 2020. We continue to believe we may see increases in demand sooner, if regions and cities are allowed to adopt earlier. If that happens, we are well-positioned and ready to meet our customers' needs. Turning to Performance Chemicals, as you can see on slide six, as expected the segment continued to face headwinds in the quarter. Segment sales in the third quarter were $172.7 million, down $19.9 million, or 10% versus the prior year. Segment EBITDA of $27.3 million was down $6.9 million, or 20%.

As we expected, these sales in EBITDA results are virtually identical to the second quarter of the year. Sales into industrial specialty applications, and these include printing inks, adhesives, agricultural chemicals, lubricants, and others, were down 10% versus the prior year period, while essentially even with the second quarter of the year. We continue to experience volume and price pressure particularly in non-derivitized upstream products. At the same time we're beginning to have some success in obtaining new business in higher value downstream applications. Sales in our oil field technologies applications were down 18% versus the prior year quarter, yet up 5% versus the second quarter, and up 14% versus the first quarter of 2016. As previously discussed, this business has been negatively impacted by low oil prices, and the consequent reduction in oil field drilling and production. While there has been a gradual upswing in drilling in the US and Canada over the past few months, we have not yet seen any significant upturn as a result. We are, however, continuing to have success introducing new products that meet the performance and cost requirements of our oil field customers. We are also successfully leveraging our global footprint, to geographically diversify sales for our expanding product line, specifically in the Middle East.

Sales in pavement technologies applications for the quarter were down 9% versus the prior year quarter, and 4% sequentially versus the second quarter of 2016. This was driven primarily due to results in China that were weaker than expected. While we typically experience a significant decline in pavement technologies application sales in China during the first year of a new Chinese five-year economic plan, sales in China in the third quarter were even weaker than anticipated. And sales in other regions of the world were not able to fully offset the decline. Year-to-date, sales of pavement technologies products in our largest market, North America, are up 8%, and sales across all regions are even with last year. While in the short-term these results are disappointing, we continue to believe that the long-term secular opportunity of pavement technologies applications is strong, and we expect to see continued strong adoption of our pavement preservation, and more mixed asphalt technologies going forward. In the quarter, Performance Chemicals benefited from lower energy and raw materials costs. These benefits along with our own cost reduction efforts helped to partially offset the revenue impacts to earnings. During the quarter, we with had a successful outage at our DeRidder, Louisiana facility in September, and the Charleston, South Carolina, shut down in the first week of October was successful, despite few days impact from Hurricane Matthew. With regard to our longer term outlook for performance chemicals, I would like to take a few minutes to discuss the current supply and demand dynamics in the global pine chemicals industry. As you know, a key raw material for Ingevity is crude tall oil or CTO. Currently there is reduced global demand for CTO for use in pine chemicals applications, due to both reductions in oil field activity, and the competitiveness of substitute products in the current market environment. As a result, the market for CTO is oversupplied. Operationally a long CTO market presents us with a challenge. Our contracts typically require us to take material regardless of demand, which results in inflated CTO inventories. In order to address this, we are choosing not to renew some supply agreements. However, the oversupply of CTO presents us with an opportunity in terms of costs. Our cost structure for CTO is based on market pricing, not energy indexes. Consequently, we are currently working with a variety of suppliers to ensure that as supply contracts reset, the new agreements reflect the market situation. While we anticipate meaningfully lower costs in the future, as we discussed last quarter, due to legacy agreements we do not expect to see significant savings until the second half of 2017. Still, due to weak demand for our refined products, our CTO refineries are operating at below capacity. There are two obvious solutions to an oversupplied market, higher demand and/or lower supply. While we do control the former, we can address the latter. It's for these reasons after evaluating a variety of options that we decided to permanently close our Palmeira, Brazil CTO refinery. In addition to an oversupplied pine chemicals market globally, conditions in South America have remained weak for an extended period, and high value derivatives applications have not developed in the region as once expected. Consequently we believe it's necessary to scale our operations to the market opportunity. The Palmeira facility represents about 10% of Ingevity's CTO refining capacity. It is also our highest cost refinery. We intend to cease production there by year-end. These decisions are never easy specially when they affect employees who have maintained such a strong commitment to the Company. The plant's closure is expected to reduce employment by approximately 80 people.

After the closure, we fully expect to be able to supply our customer base in South America more cost effectively from our US operations, and importantly, we expect to realize operational cost savings in 2017. While we see weak demand conditions for pine chemicals persisting in the near term, we do expect demand conditions to gradually improve particularly in the downstream derivatives applications where we are focused. As they do, we have ample capacity to serve our customers around the world via our low cost US refinery operations.

At this point, I'll turn the call over to John Fortson, our Executive Vice President and CFO for a detailed review of our financial status, following John I will close with a few closing remarks prior to Q&A.

Thank you, Michael. Good morning everyone. There are three areas I will cover. First, I will provide some additional color on our financial performance in the quarter and over the nine months of the year-to-date. I will review our cash generation and capital structure, and last, I'll review and provide some additional details on our revised guidance.

As Michael mentioned, the third quarter as well as performance in the first nine months of the year was strong and in line with our expectations. As you can see on slide eight, revenues of $252 million in the third quarter and $705 million for the nine months year-to-date were down 1.8% and 7% each from their prior year periods respectfully. This reflects the continued pressure on our performance chemicals segment being largely offset by continued growth in our performance materials segment. Adjusted EBITDA of $59.6 million and $163.2 million for the third quarter and nine months year-to-date respectfully, are up 5.3% for the quarter, and seasonally flat for the first nine months of 2016 when compared to last year. Margins improved in both measured periods. Third quarter adjusted EBITDA margins increased 160 basis points compared to the prior year quarter ,and 170 basis points when compared to the first nine months of the prior year. Performance materials Q3 2016 segment adjusted EBITDA of $32.3 million represents a 40.7% margin, which is up 560 basis points from a year ago, and is a 40 basis-point improvement from the second-quarter, despite a significant outage in the third quarter. On the year-to-date basis, Performance Materials segment revenue is up 17%, and adjusted EBITDA is up 32% when compared to 2015. This performance is a direct result of what Michael discussed, increased regulatory adoption, shift in mix to larger vehicles in the US, and efficient plant operations. Given the high proportion of fixed costs associated with this business, we are seeing substantial drop through profitability from its growth.

Performance Chemicals continues to experience pressure. Sales in the segment were off 10% from the third quarter of last year, and adjusted EBITDA is off 20%. Year-to-date revenue is down 15%, and adjusted EBITDA is down 24%. In light of this performance, across the Company we remain focused on cost reduction and continue to be successful in delivering significant savings across our raw materials and SG&A. We are very proud of our team for what they are accomplished in this regard. SG&A for Ingevity in the quarter was flat from the prior year's third quarter albeit on lower sales, but is down $7.6 million over the nine month comping period.

As a result of our decision to shut down our refinery operations in Brazil, we recorded a noncash pretax impairment charge to property plant and equipment in the amount of $30.2 million, and severance costs of $2 million. The severance costs are expected to be paid beginning in the fourth quarter of 2016. Refinery production is expected to cease at year-end, with decommissioning of the facilities to end by mid-2017. We expect additional exit and disposal costs to be in the range of $2 million to $3 million, and to be incurred and paid through the first half of 2017. In total, we expect this action will result in pretax charges of approximately $34.2 million to $35.2 million, of which $4 million to $5 million is cash. To give you a sense of size, our revenue from our Brazil operations represent about 2% of our total Company revenue, and the business was losing low to mid single digits of EBITDA per year. After we closed the refinery, our profitability will improve due to the closure of our highest cost facility, and servicing the profitable revenue from our more efficient US facilities. For the third quarter of 2016, we recorded net interest expense of $3.8 million. We reported a net income attribute loss of $7.1 million, which is a loss of $0.17 a share. However, when adjusted for separation standalone costs, adjusted net income attribute to Ingevity was $27.2 million, and diluted adjusted earnings per share was $0.64. On slide nine, you'll find some key balance sheet and cash flow information. Since the spin, net debt has declined by $43 million to $425 million, and as of September 30th, our net leverage ratio was 2.2 times. Total net was $521.8 million including our capital lease obligation amount of $80 million related to the Wickliffe IDB. We finished the quarter with $69 million of restricted crash for the IBD, and additional cash and cash equivalents of $27.1 million. As of September 30th, $256 million of our $400 million revolving credit facility is available to us, also due to the reduction in leverage, bank debt borrowing costs will drop by 25 basis points to LIBOR plus 150, beginning this month November.

Trade working capital was effectively flat this quarter consistent with the seasonality of our business, and driven in particular by sales of pavement technology products. Inventory was down slightly from $157 million to $155 million. Underlying these numbers the team has done a great job working down finished goods inventory in a weak demand environment, particularly for less derivativized products. However, we do hold more of these low end materials than we would like. We also continue to build CTO inventories. We are at historically high inventory levels for CTO, and expect this to be the case for some time. In light of these factors, working capital efficiency remains a priority for us in this environment.

Our CapEx in the third quarter was $15.1 million, and this translates to $37.3 million year-to-date. We do expect significant expenditures this quarter due to planned maintenance outages, cash from operations in the quarter was $37.9 million, which resulted in free cash flow of $22.8 million. Year-to-date, we have generated $37.3 million of free cash flow.

Our GAAP tax rate year-to-date is 55%. And we anticipate finishing the year with a GAAP tax rate of around 49%. This elevated tax rate is primarily due to the unbenefited losses recorded as a result of the structuring actions taken in Brazil. However, on an adjusted non-GAAP basis, i.e. excluding separation and restructuring costs, our year-to-date tax rate is 35%. And we anticipate finishing the year with a tax rate around 35%. From a cash tax perspective, when you look at our cash tax obligation for Ingevity's pretax income from the date of the spin to September 30th, it is approximately 27%. We have 42.1 million shares outstanding as of September 30th. And additional information will be available if our 10-Q, which we expect to file later today. Turning to slide ten, as we finish 2016, we are tightening and raising our guidance for fiscal year 2016 sales, to sales of between $895 million and $905 million, and tightening and raising our guidance on adjusted EBITDA to between $192 million and $197 million. As we discussed on our last earnings call, the fourth quarter is being impacted by planned outages at several of our manufacturing facilities. This is resulting in plant downtime. lower fixed costs absorption, and increased maintenance spending. The pressure in industrial specialties and oil field applications is expected to continue. We also are experiencing normal seasonal impacts including the end of the paving season, which results in significantly lower sales and profitability in the fourth quarter. We will also experience seasonal impacts in Performance Materials. However, our focus on cost reductions and operational execution will continue to yield benefits. Our tax rate is being impacted by a number of factors, but we continue to work to review our tax position globally. We now expect to finish the year with an adjusted effective tax rate of approximately 35%.

Our guidance with regards to capital expenditures and free cash flow have changed. We expect capital expenditures to be $60 million to $65 million for the year and free cash flow in the $45 million to $50 million range. We anticipate finishing the year to net debt to adjusted EBITDA at the low end of our previous guidance, somewhere between 2 and 2.25 times. As we look forward we continue to see growth from certain applications in our Performance Chemicals segment, while ensuring the cost structure appropriately sized to the market environment. Additionally we are focused on resourcing and executing to meet the rapidly growing demands of our customers in the Performance Materials segment. I will now turn the call back to Michael.

Thanks, John. In summary as we head into the home stretch of 2016, we continue to position Ingevity for growth, higher margins, and improved returns. We are focused on delivering value to our customers driving efficiencies, and creating value or our Company and shareholders. I continue to believe very strongly in the potential for our Company. We hope you will share our enthusiasm for Ingevity. At this point, Operator, we will open up the call for questions.

Thank you. (Operator Instructions). Our first question comes from the line of Ian Zaffino with Oppenheimer. Please go ahead.

Hi, Great. Thank you very much, and very good quarter. Question would be on, you talked about the sell through of the auto business. Is that like a one-time blip that you might see in like the third quarter, and then fourth quarter as the OEs stock up and build inventory? Or is this something that's going to kind of be relatively steady? And then a follow-up.

No, Ian. We think that growth that we're seeing in our automotive carbon business is consistent with what we expected with the increasingly stringent regulations, and the roll out of 2017 model year vehicles in the US and Canada.

Okay. That's good to know. And then when you look at the cost savings, the cost savings, is that all going to fall on the chemical side of it, or is there going to be some on the material side as well? When you talk about that $25 million to $30 million?

It actually is both in chemicals and materials, but the vast majority is to the chemical side.

Okay. So I guess if I kind of run that through the numbers you're kind of looking at like a high teens margin on the chemical side, even ignoring any type of revenue growth, is that sort of the ballpark?

You're talking about high teens margin in chemicals in what period?

When you run through the cost savings and you achieve the cost savings, you'd look for kind of a high teens margin on the chemical side, even in the absence of any type of recovery in the end markets, or recovery in growth? I just kind of want to be clear on that, I think that's what it seems like to me.

No. Because we are seeing the price pressure, and also the volume pressure in the segment, really what we're doing on the cost savings is helping to offset some of those margin impacts. So currently the performance chemicals business has got EBITDA margins that are in sort of the low teens area. Now we fully expect that over time we're going to drive those margins back to the historical 18% to 20% level. But that's going to be based on a number of factors. I mean, first of all, the cost savings are certainly going to benefit that, including the restructuring actions that we've taken.

We expect that our pavement technology applications, which are one of the most profitable segments in performance chemicals, are going to outpace the growth of the other segments, so we're going to see mix improvement there. And then as demand gradually comes back we'll get better utilization of our refineries and chemical assets, leading to better fixed cost absorption and margin improvement.

Okay. Thank you very much.

Our next question comes from the line of Jim Sheehan, SunTrust Robinson. Please go ahead.

Good morning. Hey John, congratulations on the Cubs victory, it seems like you've waited about 100 years for this.

I feel sorry for those analysts that might be located in Cleveland. But thank you for saying that.

So first question on the China 6 regulations, this seems like a very big deal for you guys, and sort of give me some clarity on the next leg of growth. How do you see the phase-in of those regulations occurring at this point?

Well, Jim, this is Michael. The way it works in China historically is bit different than it was in the US, where in the US there is a phase-in period over multiple years. The way the China regulations are written, the July 2020 date for compliance is for 100% compliance, so that means that at that date, if it holds, it would be expected that all new vehicles sold in China would be compliant with the new standard. So it's not a typical, so many percent per year.

Great. And also on the turnarounds that you had third quarter and fourth quarter. Could you give us a little color on what the impacts were in each quarter, what we can expect for fourth quarter on turn around costs?

Yes I think we said at our last call that we expected that relative to the first half of the year that the outage impact at the earnings level would be $10 million to $15 million. I think we're still in that range. At this point, I think we're going to have a higher proportion of the costs hit Q4 versus Q3.

Great. And then in terms of the Palmeira closure, you said you're probably going to see some savings from that. It's probably a little early to say, but can you give us kind of a rough ballpark of what you might be thinking there?

Well, I think as John mentioned in his prepared remarks, that operation was losing low single-digit mid single-digit millions of dollars on an annual basis. So certainly we'll eliminate those losses, and then hopefully service that business profitably from our North American refineries. I'll just remind you that well have some ongoing costs associated with the closure. Most of which John said would fall in Q1. So if you look at it an operational earnings standpoint, certainly it should be a tailwind to 2017. But there will be some offsets in terms of those ongoing restructuring costs.

Thank you very much.

Our next comes from the line of Mark Weintraub, Buckingham Research. Please go ahead.

Thank you. First, I just want to get a clarification on the way things phase-in in the US. I know it was 20% this is for Tier 3 in 2016, 40% in 2017, et cetera, now though, you are servicing for model 2017 years currently. So I guess what I am trying to maybe get a better sense of, if you were to estimate the percentage of the vehicles in 2017 that you are effectively selling your product to, I'm sorry or 2016, what percent would you say have adopted the Tier 3 compliance standards?

That's an interesting question, and a tough one, so I am going to pass that one to Ed Woodcock.

Good morning, Mark, based on the commercial activity that we've seen, we've see it ramping up consistent with the 2017 requirement for 40%. On average in 2016, we'd estimate it to be a 25% to 30% adoption rate.

Okay. Great. Very helpful. And then any update perhaps on Beijing. I know you mentioned China 6 and I know that's for July 2020. I think there had been some conversation that Beijing would be adopting potentially as early as next year. Is that still happening, and will that be impactful if it does?

Yes, there's actually bit of an unknown around Beijing. You recall correctly that Beijing did pass a regulation indicating that by December of 2017 that all vehicles in the province would need to comply. However, the new China 6 regulation is a national regulation. So that precludes Beijing from being able to implement a different standard, unless they went through a process to put in place a more rigorous standard. But what they may have the ability to do is to adopt the China 6 standard earlier. That would apply perhaps not only to Beijing, but other major metropolitan areas and provinces. Anything you would add to that Ed.

You answered that perfectly. So some high pollution regions might apply for this, like Shanghai and Guangzhou, and obviously Beijing with the issues that they're having. It's an opportunity that they do have, and we'll be monitoring it closely.

Okay. And then lastly, you've provided some guidance in terms of targets for the Performance Chemicals, 18% to 20% EBITDA margins over time. On the Porous Materials, you're obviously doing very well already at 40%-plus EBITDA margins this latest quarter. Are there other targets that you have out there that you're willing to share of where you think those EBITDA margins sustained, given as you point out there is the potential for significant drop-through profitability enhancement, but at the same time I am sure you're thinking through a lot of different factors as you shoot for different EBITDA margin targets in that business?

Well, really, we really only talk about it at the segment level for Performance Materials and Chemicals. And we have sort of been consistent in saying that over the next few years, as not only do we expect to see the revenue opportunity in Performance Materials double over five to seven years, but we expect margins to gradually accrete, and that really has to do with the adoption of more stringent technology, you have more highly engineered products, higher margin products. On the chemical side, again what we've committed to, is that we believe we're going to get that business back to that 18% to 20% EBITDA margin level. The time frame we've talked about is 24 to 36 months to get there. Obviously be influenced by how long the headwinds persist in places like industrial specialties and oil field, but we still remain comfortable with that time frame. We've got very detailed plans on how we're going to get there. They include the reductions that we expect to see in our CTO costs, along with growth in certain segments, the cost take outs, and a variety of actions, but it is a detailed plan.

So that's super helpful. And I probably should have just said Performance Materials, rather than Porous Materials, and just so there you're just saying you're going to accrete from where you are, no specific targets in that business that you can share?

No, we haven't given a specific EBITDA margin target.

Fair enough, thank you.

Our next question comes from the line of Daniel Rizzo with Jefferies, please go ahead.

Good morning. You indicated that China was weaker, a bit weaker than expected in the quarter for pavement technologies, is a new outlook for China in order? I mean, is it going to be a little bit slower than perhaps previously expected?

Well, certainly China in pavement technology applications is weaker in 2016 than we expected. And it's a Northern hemisphere market just like here in the US, so for the most part the paving season is done in China, just as it is done in the US, so we don't really see an opportunity to reverse the performance that we've seen in the balance of the year. And it's down substantially from where we thought it would be, despite the fact that we anticipated the weakness. However, I do believe that what we've seen is not a secular trend. It's simply a one-off item, and we really have to look at this business and the revenue trends in this business on a full year basis versus quarter to quarter, just because of the seasonality. So I caution folks to over-read too much into one quarter.

Thank you. And is this the time of the year, or like the end of fall, beginning of winter, is that like outage season or turn around season I should say for you guys, when we think about things for the next few years, is this the time where a lot of these events are going to occur?

Well, I think, historically the second half of the year have been more heavily loaded with outages for than us than to the first half, and as we talked about in the prepared remarks, we actually had three outages in the third quarter at two chemical plants and one of our carbon plants, and now we have a major outage going on at our largest carbon plant in Covington. It's our hope, quite frankly, that in future years that we can stagger the outages a bit better throughout the year as opposed to having them back end loaded. I think what happened this year was somewhat a consequence of the spin not happening until May, and working with our former owner and managing cash in the first half of the year.

Okay. No, thank you. That's helpful. And then finally, you mentioned about the seasonality in Performance Materials, maybe I'm just not thinking about it right, but I'm just wondering where the seasonality comes from in that particular segment? I understand in chemicals materials maybe I am just not following as clearly?

Certainly it's not the degree of seasonality that we have in chemicals, and particularly in paving technologies, but the seasonality in performance materials is really more around the auto companies and their outage schedules. Typically, the major OEMs will take outages around holiday periods of a week or two, and it really depends on inventory whether those are one week to two week outages.

All right. Thank you very much.

We have a question from the line of Chris Kapsch with Aegis Capital. Please go ahead.

Yes. Its Chris Kapsch with Aegis Capital Corp. So had a follow-up on the China regs, China 6. Good news there. And you mentioned the 100% adoption by 2020. Just wondering about the plant and your ramp over there and the capacity investment that you have made. I think you mentioned in the past it's sort of breakeven, currently you're in the process of qualifying shipping some product there. When do you see the, or how do you see the economics of that plant playing out as we move towards adoption of the next standard. Is the plant configured to produce the product necessary for the next standard, or would there be incremental investment required for that?

To answer the second question first, no, I mean the plant is configured to make the products that are required for future regulatory adoption and standards. We are in the process of scaling up the plant, what we have said previously was that we expected by year-end the plant would be operating at about a 30% capacity utilization rate. In part building inventory for demand that we see going forward.

Okay. So 30% utilization sometime in 2017, and just so I know, is that the production, is it entirely for captive China demand, or will that be used in any instances for export as well?

Primarily that product today is being produced for export markets but the facility is there obviously also to serve China, when the market there evolves to need, the higher grade more highly engineered products that we produce there. And just going back to your last question about the 30% capacity utilization what we said is that when we get to that level the plant is probably running at about a breakeven level. So it was a cost drag in 2015, it was a cost drag to about the same degree in the first half of 2016, and that cost drag is diminishing as we go through the second half of 2016, and I would expect it to be breakeven to slightly contributing to earnings in 2017.

Okay. And then if I had some follow-ups on the performance chemical side. You mentioned some CTO cost relief mid 2017. I think you're suggesting that was related to the contract negotiations, but just on the time line there. You are also having to work through this bloated CTO inventory that you mentioned, in order to see more substantial relief on the cost side there. Is that why it's mid-2017 and not say early 2017?

No it's really more to do with the contractual commitments that are in place. The most significant of which is the agreement with Westrock that provides almost 50% of our demand on a full utilization basis. We've talked about previously that contract included some fixed pricing and pricing floors for the first year of the agreement. So those run through mid next year. There are also other legacy agreements that were multi-year in nature. But at the same time, we are already in negotiations. We are seeing some benefits, and maybe I'll just let Ed Rose talk a little bit more about what we're doing, and what we are seeing.

Yes. Again, thanks, Michael. As it relates to CTO again, a staggered set of contracts as you can imagine, some complex in how they work, and we do see, we have seen benefits throughout 2016, and we do see benefits starting up at the beginning of 2017, but the majority of that taking place second half of 2017 and beyond.

Okay. That's helpful. And then just on the demand commentary in PC. I think you alluded to oil field sort of being up sequentially, and certainly versus earlier in 2016. Some suggestion that slightly higher oil prices here may be resulting in better activity. Can you just remind us where the demand is in terms of the applications of traditional E&P activity, or is it more hydraulic fracturing, and then I had one follow-up on I guess the competitiveness that you're seeing from non-pine chemicals based demand as well? But just on the oil field, where are you seeing the sequential strength there, and is it simply because of slightly higher oil prices?

Yes. First of all just to sort of characterize the overall business. We have a position both in drilling, but also in production. If you look historically, we are more focused or concentrated on drilling activity and production. Drilling activity in the US obviously has been impacted more than the production side, so with the demand structure there, and the volume declines we've seen in the business today, we're more balanced between drilling and production. In terms of the drilling, our products are primarily used in oil-based muds, so the deeper the drilling, or the more complex the drilling it benefits us. We're not really involved in fracing at all. But we're agnostic as to whether it's oil or gas.

And I think the comment is that if you follow rig counts in North America those have, I think they went up for something like 17 consecutive weeks until last week they were actually down I think. But they're up modestly, and we have just not seen a meaningful impact from higher drilling activity, but you did pick up rightfully on the sequential improvement that we've seen from Q1 to Q2 to Q3, and that's really more about the work that we've done on the innovation side to reformulate products that take cost out of products to meet our customers needs in a very stressed environment, but also maintaining the kinds of gross margins that we have seen historically for ourselves. So it's about delivering efficacy at lower costs, and those products are being embraced by our customers, and that's pulling through some volume for us that you're seeing. In North America and then we're taking that same portfolio of new products, as we try to increase our geographic presence into the Middle East in particular, and we're starting to get traction there as well. So to summarize that, I think what we're seeing in terms of sequential benefits in oil field is more due to our activities and our successes than it is the overall level of activity in the marketplace.

That color is very helpful. Then just the one area where it seems the competitive pressure to alternatives to pine-based, pine chemicals based is in the adhesive end market, tackifier specifically. Can you just put some color around what sort of scenario in the energy markets would help pine based tackifiers be more competitive with the hydrocarbon-based alternative? Thanks.

I'll let Ed Rose comment on that.

Yes. Thanks for question. Again, as oil drops, obviously, it puts some of the by-products of oil in this case some of the C5 resins in a more competitive space, where they typically haven't been. And then supply and demand dynamics really are really in control here, where overproduction of isoprene, one of the derivatives downstream of crude oil, that then leads to C5 is what's really driving the pricing scenarios that have been talked about in the adhesive resin space with the C5 issues, the pricing of oil is probably to a lesser extent involved in that, and again, it goes back to classic supply/demand dynamics.

I would just add to that when we look at our adhesives business specifically, it's not quite as broad-based as some others might be, and to some degree, gum resins are probably a more competitive substitute, or the one that we would find ourselves competing against with more than the C5 hydrocarbon resin, so we're a little less sensitized to the hydrocarbons.

That's helpful, thanks.

We have a question then from the line of Curt Siegmeyer with KeyBanc Capital. Please go ahead.

Good morning, guys. Nice quarter.

Thank you.

Just a couple of follow-ups, most of my questions have been answered. On the pavement business in China, could you remind us how much of the pavement business is in China?

I think what we said if you look at 2015 results, it was probably about 10% of our total pavement technologies revenues. If you want to bracket that, it's probably 5% or less this year. So it's a significant decline.

And is it primarily market-driven, or are there any other competitive factors that play or anything else?

It's really market-driven and infrastructure spending driven by the Chinese government. The business that we have there, if you think about our business, we talk about products both for road construction, but also pavement preservation, so road construction in North America, for example, is a big use of our Evotherm and Evoflex type products. And then we have the pavement preservation product line. The Chinese market line is much more pavement preservation driven. It's really around how many road miles of highways does the Chinese government want to try to put down this thin layer of asphalt over in any given year, and historically we just found that in the first year of five-year economic plan, they really ratchet back the spending. Now that might be exacerbated a little bit this year, just because the Chinese economy is weaker than it has been historically as well.

Okay. Thanks. That's very helpful. And then maybe just one on the general, on the broader chemicals business. You talked about the time frame in getting back to the 18% to 20%. How should we think about 2017 in terms of EBITDA margins, sort of maybe first half versus second half, with presumably a nice step up in the second half with the CTO benefit that you talked about?

Well, we're not really giving any specific guidance and 2017 at this point. We'll likely do that at our fourth quarter call. But as we said, we'll see more meaningful CTO cost reductions beginning in the second half of 2017. So I mean, it should be a tailwind to the second half versus the first half of next year, but we'll see other impacts gradually throughout the year as well.

Okay. Great. Thanks.

(Operator Instructions). We have a question from the line of Jim Sheehan from SunTrust Robinson. Please go ahead.

Thank you. On the mix improvement you saw in the third quarter, was any of that related to air induction systems, and if so, what kind of uplift do you expect to see from that in 2017?

Ed, do you want to take that?

Yes, I can as we talked earlier our air induction system is another area for us to generate revenue and income from on evaporative emission standards being implemented now through 2022 for the US and Canada. It is a growing business for us, but it is a relative percentage of our overall business, automotive business, it's really actively small but growing. So we do see increased revenue, but overall significance relatively low being more weighted towards what's happening for the canister, than what's happening on the air induction side.

Thank you very much.

At this time, there are no other questions in queue.

Well, I would like to thank everyone for your time this morning. We remain very positive about our long-term outlook for our business, and we look forward to talking to you next quarter. Take care, and go Cubs.

Ladies and gentlemen, the replay information is available in the news release. This does conclude our conference for today. Thank you for your participation, and for using AT&T Executive Teleconference Service. You may now disconnect.