Ingevity Corp (NGVT) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Ingevity Second Quarter Earnings Conference Call. (Operator Instructions) And as a reminder, today's call is being recorded.

I'd now like to turn the conference over to Mr. Dan Gallagher. Please go ahead.

Thank you, Art, and good morning, everyone. Welcome to Ingevity's Second Quarter 2017 Earnings Conference Call. Earlier this morning, we posted a presentation under the Investors section of our website that we will be speaking to today on today's call. If you haven't already done so, I would encourage you to download this file in order to follow along on the call. You can find it by visiting ir.ingevity.com under Events and Presentations.

On Slide #2 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 from these forward-looking statements are contained in our earnings release and in our SEC filings, including our Form 10-K and our most recent Form 10-Q.

Ingevity undertakes no obligation to publicly release any revision to these projections and forward-looking statements made during this call, or to update them to reflect events or circumstances occurring after the date of this call. As a reminder, the company has made certain revisions to previously issued financial statements. These revisions can be found in our news release issued yesterday afternoon.

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 financial measures are included in our earnings release and can be found on the Investor Relations section of our website.

Our agenda is on Slide #3. With me today are Michael Wilson, President and CEO; and John Fortson, Executive Vice President and CFO. First, Michael will comment on the highlights of the quarter, and then he will review the performance of our 2 segments. John will discuss our current financial status and our revised guidance. Then Michael will make some brief closing remarks before we open up the lines for Q&A. Joining Michael and John during the Q&A portion of the call will be Mike Smith, President of Performance Chemicals; and Ed Woodcock, President of Performance Materials.

With that, I'd like to turn the call over to our President and CEO, Michael Wilson.

Thanks, Dan. Good morning, everyone. Thank you for joining us this morning and for your continued interest in Ingevity.

So I'll turn to Slide #4, you'll note some highlights for the quarter. We delivered strong financial results in the second quarter. Revenues grew by $15 million or a little over 6%, while adjusted EBITDA of $67 million was up versus the prior year's quarter by approximately 15%.

Halfway through the year, our Performance Materials segment is realizing the growth we anticipated in the global automotive markets. In addition, we are achieving better-than-expected results in our Performance Chemicals segment due to the team's strong execution as well as improving market fundamentals.

Revenues and earnings were driven predominantly by volume gains. Earnings were further augmented by the lower cost structure we put in place via strategic initiatives over the last 18 months. Lower raw material costs, particularly for crude tall oil, or CTO, and manufacturing efficiencies. These positive impacts were partially offset by higher SG&A costs and negative foreign currency exchange impacts.

If you'll recall from last quarter, we began to see more positive results in our Performance Chemicals segment. As evident on Slide #5, that trend continued in the second quarter. Segment sales in the second quarter were $171 million and were essentially flat versus the prior year, as gains in sales to oilfield applications were offset by lower sales in industrial specialties. Despite flat revenue, we grew segment EBITDA by 10% due to higher oilfield volumes, lower raw material costs, particularly CTO, and higher manufacturing efficiency. Segment EBITDA was $31 million, up $3 million versus the prior year quarter. This translated into a segment EBITDA margin of 18.4% for Performance Chemicals.

While the second quarter is a seasonally strong quarter for this business, this result underscores the potential profitability we see for it going forward. Sales into industrial specialties application, and these include printing inks, adhesives, agricultural chemicals, lubricants and others, were down about 5% as tall oil fatty acid, or TOFA, availability was constrained due to strong demand in oilfield and pavement applications.

As demand increases for higher-value, derivatized products sold into our other applications, it inherently has an impact on the quantities of TOFA available to industrial specialties and adhesives. In addition, we continue to see soft rosin demand and price pressure due largely to tapering demand for printing inks.

As we discussed last quarter, since TOFA and rosin are produced in fixed ratios and since we run our refineries at a rate that matches rosin supply to demand, we expect our production of TOFA to remain limited and short of demand for the balance of the year.

Much like last quarter, however, we are continuing to see strong demand in some smaller niche application, such as agricultural chemical. Our agriculture products are lignin-based derivatives, which provide valuable dispersant properties for our customers.

Sales of oilfield technology products were up again sharply. We experienced a 35% increase in revenues versus the prior year quarter. In addition to increased TOFA sales, we've been successful in executing our strategy to convert customers to higher-value, derivatized TOFA-based products. We have also successfully increased TOFA pricing due to tighter supply and demand conditions, though pricing remains below prior year levels.

Growth stemmed from the continued rebound of the U.S. drilling market. U.S. rig count as of June 30 increased to 940 compared to 431 in the prior year and 824 on March 31. Anecdotally, our teams are seeing improvements in rig efficiency, which could begin to slow the pace of growth in rig count going forward.

Sales in pavement technologies for the quarter were down approximately 1% versus the prior year's very strong quarter. Due to weather, we saw a later start in the North American paving season this year. However, strong order patterns began to emerge in June, which, in fact, was an all-time record month for the business. Also, declining raw material costs in new products are helping to drive even stronger gross margin for pavement technologies. In addition, we experienced improved profit margin in China for pavement technologies products, albeit from a small base, as we restructured our go-to-market approach in China, which is more aligned with the current market opportunities.

So as you can see, we're starting to realize the benefits of an upturn in our Performance Chemicals segment as a result of the own strategic actions and improved pine chemicals' supply-demand dynamics.

Summarized on Slide 6, our Performance Materials segment, once again, delivered outstanding financial results. Segment sales of $90 million were up $15 million or about 21% versus the second quarter of 2016 due largely to increased volumes. Segment EBITDA of $36 million were up about $6 million or over 19% versus the prior year. Earnings were aided by the scale-up and increased utilization of our Zhuhai China facility, while partially offset by higher plant spending in support of higher volumes.

Segment EBITDA margins of 40% were down slightly year-over-year. This belies the operating performance of the segment as earnings on higher net sales were negatively impacted by foreign exchange translation losses during the quarter. Excluding intercompany FX impacts, EBITDA margins in the Performance Materials segment were 42.3% versus 40.7% in the prior year period. John's going to provide more details on this in a few minutes.

Adoption of Ingevity solutions for U.S. Environmental Protection Agency Tier 3 and California LEV III near-zero evaporative standards for gasoline vapor emission control drove this increase. Our solutions include our honeycomb scrubbers, made in our Purification Cellutions joint venture, and our activated carbon sheets. Tier 3 LEV III adoption appears to be on track with mandated levels as automakers and their suppliers make the necessary platform changes for 2018 model year vehicles. As a reminder, at least 60% of all 2018 model year vehicles must comply with the near-zero evaporative standards.

Generally, increases in light vehicle sales are additional benefit to this business. However, U.S. auto sales are weakening slightly from last year's record 17.5 million vehicles. That said, forecasts remain intact for 16.9 million, 17.1 million vehicles to be sold in the U.S. in 2017. Currently, the industry is working down inventories in alignment with these forecasts.

Partially offsetting the marginally declining sales rate, we will continue to see a beneficial shift to larger vehicles, which use higher quantities of our products. In the second quarter of 2017, light trucks comprised 63% of light vehicle sales, while in the second quarter of 2016, they comprised 59%. All of these assumptions are embedded in our revised guidance.

Turning to Slide #7. You may have seen that last month we announced that we will be building a new activated carbon extrusion plant in Changshu, China. This state-of-the-art extrusion facility is a key component of our multiyear expansion plan to support growth in this business and includes additional investment in extrusion capacity and a likely brownfield activated carbon capacity increase in Covington, Virginia by 2019 or 2020.

The Changshu plant is a capital-efficient investment in our capability to turn lower-margin activated carbon powder into higher-margin automotive products. The new plant represents an investment of approximately $20 million. Just over half of the expenditure is planned capital spending that will be incurred in 2018. This project is part of our existing long-term plan.

The plant is expected to be operational by the fall of 2018 and will employ about 80 people. It will initially feature 1 extrusion line that will complement existing extrusion facility in Wujiang, China. The facility will be able to accommodate an additional extrusion line as demand warrants.

At this point, I'm going to turn the call over to John Fortson, our Executive Vice President, CFO and Treasurer, for a more detailed review of our financial status and outlook. John?

Thank you, Michael. Good morning, everyone. There are 3 areas I will cover. First, I will provide some additional color on our financial performance in the quarter and over the first half of the year. I will review our cash generation and capital structure. And last, I'll provide some details on our revised guidance.

As Michael discussed, the second quarter was strong. Looking at the income statement on Slide 8, there are few items worth noting beyond what Michael has already covered. First, in addition to the strong second quarter, our year-to-date performance has also been solid. Revenues of $479 million for the first half were up 7.6% from the prior year period, and adjusted EBITDA of $117 million for the first half were up 10% when compared to last year. Adjusted EBITDA margins improved 50 basis points when compared to the first half of prior year. This half year comparison is inclusive of a tough comparable period due to the strong first quarter 2016 EBITDA in the Performance Materials segment, which we discussed in our last call. Overall, like our second quarter, the first half of 2017 reflects the continued strength in our Performance Materials segment and improvement in our Performance Chemicals segment.

Second, as Michael mentioned, segment EBITDA margins for Performance Materials of 40% were 40 basis points lower than the same period last year. However, when you adjust for intercompany foreign exchange exposure, the Performance Materials segment improved its EBITDA margin by a 160 basis points over the second quarter of last year. This intercompany FX exposure is the result of loans between our Belgian and Chinese entities that were put in place as a part of the separation of Ingevity from our former parent. Over the course of this year, the weakening RMB has negatively impacted our margins. We have subsequently, on May 22, put in place a cash pool and bank account structure in Europe that will eliminate the impact of these currencies' moves on EBITDA going forward.

Third, you'll note that for the second quarter of 2017, we recorded net interest expense of $2.8 million. Due to the reduction of our net debt to EBITDA ratio, the pricing for our revolver and term loan will fall an additional 25 basis points starting in the third quarter. Net income attributable to Ingevity was $32 million, this translated to diluted earnings per share of $0.76 for the quarter, adjusted diluted earnings per share were $0.78. This represents a 16% increase in diluted adjusted EPS, both on a year-over-year quarterly comparison as well as when comparing the first half of this year to the comparable period last year. On a GAAP basis, these increases are 33% and 53%.

As of June 30, Ingevity has 42.1 million basic shares outstanding and 42.4 diluted shares outstanding. Starting in the second quarter, consistent with our commitment to offset employee stock award dilution, we purchased 12,400 shares of our common stock at a weighted average cost per share of $57.88.

On Slide 9, you'll find some key balance sheet and cash flow information. As of June 30, our net leverage was 1.8x. Total debt was $481 million, including our capital lease obligation amount of $80 million related to the Wickliffe IDB. This is down from $570 million of total debt a year ago. We finished the quarter with $41 million in cash and an additional $70 million in our restricted investment account for the IDB. As of June 30, $297 million of our $400 million revolving credit facility was available to us.

We have been tightly managing our working capital through our growth, and we are appreciative with the work done by our S&L teams and supply chain teams in this regard. In an environment where sales grew by $15 million from the comparable period last year, net inventories were reduced. This is despite the fact that we are building inventory of Performance Material products in China to fulfill the anticipated demand in that country and is due to reductions of raw material prices, primarily CTO, in the Performance Chemicals segment.

Accounts receivable were essentially flat, and accounts payable fell $13 million. The prior year account payable balance includes certain onetime payments due to WestRock following our separation. Excluding these amounts, the accounts payable balance year-over-year was essentially flat.

We generated strong cash from operations in the second quarter as our Performance Materials segment continues to become a larger portion of our business and the profitability in our Performance Chemicals business improves. Working capital management, coupled with a strong cash from operations, led to free cash flow in the quarter of $35 million and $31 million generated to the first half of the year.

Our capital expenditures in the first half of the year were $22 million. $12 million of which was spent in the second quarter. As a reminder, our CapEx spending is weighted towards the back half of the year due to the timing of major outages.

Additional financial information will be available on our 10-Q, which we expect to file later today.

Turning to Slide 10. We are raising our guidance for fiscal year 2017 to sales of between $940 million and $955 million and adjusted EBITDA of between $220 million and $230 million. At the midpoint, this implies year-over-year growth of 4% and 11% for sales and adjusted EBITDA, respectively.

Over the next 2 quarters, we anticipate continued sales and margin growth in both our Performance Chemicals and Performance Materials segments when compared to last year's comparable periods. We expect sales and margins in our oilfield applications to remain solid as well as a strong finish to the paving season. Additionally, we are benefiting from our cost reduction initiatives, reduced raw material costs in both planned and supply chain efficiencies. The continued sale of our EPA Tier 3 California LEV III Solutions to meet the regulatory requirements for passive auto emissions in the U.S. and Canada will result in continued growth and accelerated margin accretion in the materials segment in the back part of this year, particularly in the fourth quarter.

Partially offsetting these positive trends is expected reduced auto production models. These tailwinds will also be partially offset by normal seasonal impacts, including the end of the paving season and the end-of-year auto production slowdown, which results in reduced operating throughput and significantly lower sales and profitability in our fourth quarter. Additionally, we will be impacted by planned maintenance outages in several of our facilities, which occur in the back half of the year.

We are lowering our expected tax rate to between 32% and 34% as we have reduced operations in jurisdictions where we were unable to take advantage of tax losses. We remain focused on continued improvements in our tax-planning processes.

We are also lowering our expected CapEx for the year to between $55 million and $60 million. Our operations teams continue to be very disciplined in capital spending. Due to this reduction in anticipated CapEx and the strength of our cash from operations, including working capital management, we are raising our expected free cash flow generation estimate to be between $100 million and $110 million for the year.

We expect to finish the year with net debt-to-EBITDA, excluding the trust lease obligation in the associated restricted cash, of approximately 1.5x. We'll remain focused on disciplined execution across the company through the remainder of the year.

I will now turn the call back to Michael.

Thanks, John. In closing, this is a very good quarter for us, marked by a continued rebound in Performance Chemicals and continued strong growth in Performance Materials. We're confident in our ability to hit our revised guidance. And as such, we expect to turn in a strong performance in 2017, with double-digit adjusted EBITDA growth at the midpoint of our guidance. We continue to believe very strongly in the potential of our company, and we hope you share our enthusiasm for Ingevity.

At this point, operator, we'll open up the call for questions.

(Operator Instructions) Our first question is going to come from the line of Jon Tanwanteng from CJS Securities.

The portion of profits that went to the honeycomb JV was down from Q1. Does that mean honeycomb sales decreased sequentially at all? And is there any read-through to adoption rates?

No. It's just a matter of timing of revenues. Yes, I -- we caution this every quarter, but you really have to be careful about looking at our business on a quarter-to-quarter basis. We encourage you to look at the full year.

Okay, fair enough. And then when we look at the margins in the chemicals segment, I believe the bulk of the improvements in input costs are actually going to happen in the back half of this year. Should we still think of margins as improving sequentially going forward in that segment? Or what are the puts and takes to that?

Consistent with what we said historically, we believe that we're going to return this business to its historical 18% to 20% margins from the 13% margins -- EBITDA margins that it earned in 2016. I think you're going to see a meaningful move in that direction when we get to year-end 2017. And I expect continued accretion in those margins to get to that historical rate, which I believe we'll now achieve by 2019.

Got it. And then just on the oilfield side. Do you see rig counts peaking here? You also mentioned increased efficiency in that segment. Are both of those built into your guidance?

Yes. I mean, I think we have a sufficiently conservative guidance built into our forecast. There's no question that if you follow the rig counts, I mean, after strong growth over the past 12 months or the month-to-month, the growth rate in rig count has been slowing as of late. I think part of that is due to the efficiency that they're driving in the rig productivity. But most of it, obviously, it's going to be dependent upon what happens to the oil prices. But based on our view of the marketplace, we are confident that we're going to continue to see strong demand for our products through the end of this year at a minimum. I think if we go into 2018, we'll update that forecast as we have a better sense of where oil prices and other factors are trending.

Okay, great. And then any update to the rollout of -- or pull-in of emission standards in China by a province basis?

There's no update since our last quarterly call. We announced at that time that the Hebei Province had indicated that they were going early. To date, no other provinces have announced a similar intention. And it's just not something that we want to speculate on, but we'll certainly pass along the info as soon as we're aware of it.

And your next question comes from the line of Mark Weintraub from Buckingham Research .

Two quick ones. One, I just wanted to make sure I got -- the free cash flow, obviously, a very big increase there, $20 million. It seems like about $5 million maybe is higher net income, $5 million lower CapEx, and then $10 million, the improved working capital. Is that about right?

That's about right. We market, going into the year, as we projected our inventory levels and working capital, I think we were taking a very conservative posture given the business environment. But as we see an improvement in the chemicals segment, we've been able to sort of manage through that. And they've done a great job kind of managing inventories and freeing up cash as we -- as they've seen the recovery. So...

Okay, great. And when would you potentially get any sense of when -- what plan do U.S. carmakers would have for next year in as much as you're going to have the new regulatory -- the 80% kicks in 2020? So in theory, they could do not a lot in 2018, or they could kind of continue along the path in 2018 and do half of it in 2018 and half of it in 2019. When do you think you might get a better view as to what the plans of the carmakers would be?

Mark, it's Michael Wilson. I think the answer to that question is we don't really know, to be perfectly honest about it. We believe that they are certainly on track to meet the 60% adoption requirement for 2018 model year vehicles. As it relates to getting from 60% to 80% by 2020, it's really something that is difficult to predict because there's a lot of moving pieces to this. But if the sort of performance to date is any indication, I would say their tendency is to run ahead and certainly not lag the adoption curve.

Okay. And then lastly, with progress in Performance Chemicals occurring at, I think, even a better speed than you were originally anticipating, I assume though that would then change the 18% to 20% target range. Is there reasons to believe that could be higher? Or is it that the performance you're seeing can raise the bars? Is it more it's speeding it up?

I'm going to leave it at I'm very optimistic about the direction of our Performance Chemicals business. And again, I think we clearly see the 18% to 20% in 2019 timeframe. Let us achieve that, and then I'll come back and tell you how much higher we're going to drive it.

And our next question will come from the line of James Sheehan from SunTrust.

A question on your plant spending for the Zhuhai, China plant. What kind of impact did that have on your EBITDA in the quarter? And also, do you see those impacts continuing in the second half? Or are those moderating as you run the plant harder?

I'm not sure we get so granular to talk about the additional costs from the ramp-up. What I would say, Jim, is that if you think back to what we talked about in 2016, the Zhuhai plant was sort of a drag on earnings. So in other words, it had operating losses for the full year in 2016. We talked about, at the beginning of this year, that we thought the plant would be at more or less at breakeven rate. I would say, right now, my expectation for the full year is that it's actually going to be breakeven to accretive to earnings by sort of single-digit millions of dollars.

Great. And in Performance Materials, your SG&A costs were slightly higher. Is that a transitory thing for the quarter? Or should we expect that to continue in the second half?

Yes. So let me just acknowledge 2 points here. I mean, first of all, we have a fairly simplistic mechanism for allocating SG&A costs. We do that as a percentage of sales to our business. So we may look at doing something different in the future, but that's how we've done it. As you know, we push all corporate costs to the business. And so as Performance Materials, over the last couple of years, has grown at a much faster pace than Performance Chemicals -- in fact, we have seen a decline in revenues from its peak in 2014 -- Performance Materials is picking up a proportional increase in the share of our total SG&A costs. So keep that in mind. In terms of the overall SG&A costs being up, part of it is the annualization of having full standup cost in the company. The other part that I would acknowledge is variable compensation. Due to the performance of the company, we expect that our incentive plans will have higher payouts in 2017 than in 2016, and that's driving a portion of the SG&A.

Great. And you're generating a lot of cash right now. That's probably going to continue with your net debt-to-EBITDA now looking like it's 1.5x in 2017. It seems like you've got a high-class problem here. You're underlevered. Can you talk a little bit about your priorities for uses of cash going forward?

Absolutely, you're exactly right. The outlook is to be about 1.5x net debt-to-EBITDA. And we've talked about the fact historically that we're comfortable operating in the 2x to 2.5x leverage position as sort of an ongoing basis. So it is a high-class problem. In terms of capital allocation priorities, again, our priorities are, one, to fully reinvest in our existing businesses, particularly, the Performance Materials business, to be sure that we fully support the organic growth that we see in that business. And you're seeing us put capital into that business, both in our Purification Cellutions joint venture that makes the honeycomb scrubbers and also with the Changshu investment, and there will be others. Performance Chemicals, which, again, I think, is showing a very positive turnaround, really doesn't require a lot of capital going forward. We're still operating assets at well below capacity. So we can support additional growth there. So that's our first priority, our second priority, as we've talked about, is that part of our strategic plan is inorganic growth and acquisitive growth. We've talked about the fact that beginning -- we started this year, we put the capability and processes in place to begin screening opportunities, looking for value-creating opportunities for shareholders. We've, in fact, bid on a number of properties during the first half of this year, but have yet to be successful. And I'm not going to speculate as to when we will be, but we're confident there are good opportunities out there. We're going to find value-creating ways to invest the cash that we have. If we can't, we will find a tax-efficient way to return that capital to shareholders. I know that we have, as we indicated in our last call, a $100 million share buyback authorization. We've used very little of that. We have been consistent that we bought back enough share to offset dilution from incentive compensation, but we really haven't done much else to that. But I can assure you, we're going to deploy that capital in a way that has high returns or we will address the underleverage situation that we have going forward.

And our next question comes from Curt Siegmeyer, KeyBanc Capital.

Just a couple of quick ones, one on the guidance. Is the bulk of the increase due to the chemicals segment coming in better than expected? Or is part of what you're seeing in materials also baked into that?

I think consistent with our prepared remarks, I think the Performance Materials business is basically delivering to the expectations that we had at the beginning of the year, and much of the upside, unfairly, is with chemicals. So I leave it there.

Is that a combination of both better end market as well as the raw material benefits that you're seeing? Or is it that kind of more on the raw material side?

I think it's a benefit of a number of things. I mean, first of all, it's a benefit of the cost structure that we put in place over the last 12 months or so as we look to restructure the Performance Chemicals segment. I think part of it is raw material costs, particularly CTOs we've talked about. And the third piece is improving supply-demand dynamics in the pine chemicals segment. So it's a combination of all those things. And I think, going forward, it also gets augmented by continued innovation, continued reformulation of products to provide solutions for our customers, to create value for them and to capture more of that value for ourselves.

Great. And then just a follow-up on materials. The top line has been really strong year-to-date, and it's pretty impressive given the auto market is looking like production will be down modestly this year. And you guys have talked about your ability to grow even in a flat, maybe down slightly market in the past. So how far would production have to fall before it'd be maybe more challenging for you guys to be able grow with adoption rates where they are?

Look, I think we're going to have strong top line growth in this business regardless. I can't see the SAAR rate or the sales rate fall into a level that we're not delivering strong growth. Clearly, it has a marginal impact. And I know as it falls, the impact would get greater, but the regulatory adoption is so much more of a strong driver that we're going to see strong revenue growth. And our second-half forecast, I believe, reflects that.

And Daniel Rizzo with Jefferies.

With the new extrusion plant expansion, do you have enough capacity to meet the anticipated Chinese demand increase in 2020? Or is another wave of expansion going to be necessary?

Dan, this is Michael Wilson. As I indicated in the prepared remarks, I mean, we obviously look closely at capacity and the sort of coming waves of demand that we're going to see in China. We think we're making the necessary investments to fully realize the growth potential associated with that and to meet demand. I did indicate in the comments that we expect that we'll probably need to add carbon activation capacity. So this is the kind of capacity that we have in Wickliffe, Covington and Zhuhai, probably sometime in the 2019, 2020 timeframe. Part of that depends on whether other provinces in China decide to accelerate ahead of the national mandate. But again, we'd mentioned that, that investment is not likely to be of the magnitude of the greenfield plant we did in Zhuhai, which was more than $100 million. It was likely to be something that's 50% to 60% of that investment. It would be an existing facility, and we've sort of called out, at this point, the Covington side.

Given that it's a brownfield and not a greenfield, what's the -- I mean, how long does it take it to kind of get it ramped up? Just a few months?

No. I mean, we'll be planning that. We're already looking into the options, assessing the options, doing preliminary engineering. So not exactly sure when we would pull the AFE forward for that. But the construction period for something like that is probably 18 months.

Okay. And then you indicated that wet weather led to a kind of slow start in pavements. I was wondering if that leads to a pent-up demand or it's just kind of -- I mean, you just kind of lost that and just moved forward from there with stronger demand as anticipated. But because it started wet, that's just kind of gone.

No, I think we're going to see a stronger third quarter as a result of the slow start in the second quarter. So our outlook for that business on a full year basis remains intact. As I said, we really saw the order pattern shift, beginning in June. And our outlook in the third quarter is off to a great start.

And our next question comes from line of Chris Kapsch with Aegis Capital.

A follow-up on the discussion around Performance Chemicals and the raw material costs. You mentioned CTO costs benefited the quarter a little bit. I was wondering if you could quantify, maybe in basis points, the benefit to the margins. And the reason I'm asking is, obviously, the majority supplier, I believe, the contractual step change in costs from your biggest supplier happened on July 1. And so I sort of thought the other suppliers were kind of either simultaneously or lagged sort of linked to that contract, maybe not leading. So is the market for CTO generally oversupplied? Or was there a downdraft in spot pricing that benefited ahead of that contractual reset? If you could just talk about the dynamics there, it would be helpful.

Sure, Chris. I don't want to get so granular to try to quantify the savings or margin improvement for CTO alone, but I do want to clarify the situation in CTO. I think we've talked about in numerous occasions that our largest supplier was from our parent company that we received the 10-year supply agreement as part of the spend of the company. That is a market-based contract for the supply of CTO, but it did have fixed pricing in it for the first year. The fixed pricing really expired at June 30. So now the pricing for the majority supply, which is coming from WestRock, will begin to reset to a more market level. But the way that contract works is that the pricing resets on a quarterly basis, but there's about a one quarter lag. So -- and the way the pricing works is that there's a market basket of prices that we have from our other suppliers, and weighted average of that market basket becomes a proxy for market price. So what you shouldn't expect is the sort of a step change cliff function of reduction in CTO from Q2 to Q3. There's a lot of complexity in the way our contracts work among various suppliers, and there's a dozen more paper mills that are part of that supply. Some of those contracts are actually interrelated to one another. It can become somewhat of a circular calculation. So what I can tell you is that CTO prices have been a benefit for the first of the year. We expect that they will continue to be a tailwind. And at this point, I really see falling CTO pricing a tailwind for at least the next 6 to 7 quarters. And I can say that with confidence because we already have locked in those agreements and purchases through 2018. So you shouldn't think about this as a step function, you should sort of think about this as a slow downwards spiral of CTO that's going to be a tailwind for us gradually over the next few quarters. Does that help?

Yes, that's helpful. I mean, so the benefit in the quarter was really from, obviously, the non-WestRock suppliers. And it sounds like, I'll call it, a virtuous cycle here over the next 1.5 years.

You've got it. That's correct.

Okay. And the other question I had on the PC side was around TOFA and the tightness in the market there, obviously, benefiting from the increased derivatization of TOFA and the oilfield demand. Just wondering though, the rest of the TOFA customers and end markets, are they on allocation? I mean, it seems like TOFA's tight, and I'm asking because also curious about how much of the price increase that was announced has gotten through, and is it so tight that it might be shut up for, it sounds like, another price increase. And just wondering what your thoughts are around that.

That's a great question, Chris. I'm going to let Mike Smith handle that one for you.

Chris, we actually have been looking at the allocation of our customers for TOFA, clearly, moving them to the higher-value applications. You mentioned the derivatized products, which are our primary focus to make sure that we grow and support those products. And then a number of TOFA customers, frankly, that we had overseas that often have other substitute facts that they can use have been the types of customers that we have no longer continue to serviced, and so therefore, have a very positive mix from that standpoint. And yes, we have had a very good success, to date, in the execution and implementation of our TOFA price increase.

Okay. And so there's no reason to think -- given even with some -- with the rig count, even if it flattens out, even if there's more efficiencies in production from those deployed rigs, it doesn't sound like there's any reason to suspect that the tightness would change, certainly through the balance of calendar '17. Is that fair?

That's correct.

Okay. And then just one follow-up on Performance Materials. I think you mentioned that utilization in your existing China plant benefited the results a little bit. And presumably, that means more demand. I'm just wondering if the demand pickup that you saw there was related more to the domestic market and adoption of the evap standards in China. Or are you also seeing more opportunities to export from that product?

Yes, Chris, it's 2 things. One is we do have qualified customers that we are exporting to, that we're selling products out of that facility, too, multinational OEMs. But the part of it, quite frankly, is that we're using this opportunity to build inventory in that facility, in that business, in anticipation of what we know is coming.

I see. So the unit costs were better on the inventory built?

Yes.

So -- and then regarding the extrusion plant that you're building. Can you just talk about the timeline? And then where are you going to be supplying that activated carbon from? Is there a knock-on benefit presumably from better plant loading from wherever you're supplying the carbon?

I'll let Ed Woodcock answer that for you.

Yes, Chris, good question. Actually, the timing on the plant, first, is construction is underway. We expect it to be up and operational by the end of 2018. The product that we will be extruding is currently what we sell into the process purification market. So that powdered carbon, we will be having a nice mix upgrade by shipping it from the lower-value process purification application into an automotive product and begin selling it at a much better value proposition for us.

So -- right. So more of a mix benefit than a manufacturing utilization benefit, but benefit nonetheless, it sounds like.

And next we have Ian Zaffino with Oppenheimer.

This is [Mark] on for Ian. I just want to get your gauge on the industrial specialties demand in Performance Chemicals. Just wondering when we can expect an improvement in the space and what you guys are seeing in terms of current drivers of weakness and [callous] for rebound?

Yes, I think what we've seen in industrial specialties is a lessening of the pressure across those applications in aggregates. I mean, clearly, oilfield, as we talked about, has seen a significant rebound with a 35% revenue growth in this quarter versus the same quarter last year. Pavement, we're going to continue to see solid growth in that business and margin improvement because of lower costs. But when you look at the segment as a whole, I mean, if you look at the pricing impacts that we had in that business in Q1 and you compare the same in Q2, you can see that some of the pricing pressures began abating. So we talked about 2 value streams there, the TOFA stream and the rosin ester that leads to resin stream. And TOFA is experiencing -- no. Really, demand that's outstripping supply. But the rosin market remains soft, mostly because of [wide kinds] pine chemicals competition, but also because of other substitutes. We're not at a point there yet where we're seeing significant growth nor we're at a point where the supply-demand is where we have a lot of pricing leverage. But we'd certainly seen a bottoming of the pricing pressure in that segment. So I think it's set up well as we go forward. We're just clearly being cautious about the recovery at this point.

Okay. Got it. That's very helpful. And then if you don't mind, I guess a quick one on your sense of I guess expectations for TOFA for the balance of 2017. And then if you could give any sense of expected tonnage or capacity on your end?

Well, we don't really talk in terms of tonnage. We talk more in terms of revenue as being a specialty business. But again, we clearly laid the expectations that we think the dynamics are such that demand is going to remain strong for this TOFA-based products for the balance of the year.

(Operator Instructions) And speakers, no one else is queued up. Please continue with any further remarks.

Thank you, Arthur. I want to thank everyone for your time and interest this morning. Obviously, we remain very positive about the long-term outlook for our business, and we look forward to talking with you again next quarter. Take care.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation, and thank you for using the AT&T executive teleconference service. You may now disconnect.