Good morning. My name is Brica, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Ingevity third quarter 2022 earnings call and webcast. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press star, then two. Thank you. John Nypaver, Treasurer of Investor Relations, you may begin your conference.
Thank you, Brica. Good morning, and welcome to Ingevity's third quarter 2022 earnings call. Early this morning, we posted a presentation on our investor site that you can use to follow today's discussion. It can be found on ir.ingevity.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, Mary Hall, our CFO, Ed Woodcock, President of Performance Materials, and Rich White, President of Industrial Specialties and Pavement Technologies. In addition, Steve Hulme, President, Engineered Polymers, and Erik Ripple, Chief Growth and Innovation Officer, will be available for questions and comments.
John will start us off with some highlights for the quarter. Mary will follow with a review of our consolidated financial performance. Rich, on behalf of his Performance Chemicals segment colleague, Steve Hulme, will discuss the entire Performance Chemicals segment, and Ed will review the results of Performance Materials. Finally, John will conclude with our outlook for 2022. With that, over to you, John.
Thanks, John, and good morning, everyone. Please turn to slide four, and we'll jump right in. Ingevity had another great quarter, and I wanna thank everyone on the team for how well they have navigated the current market. This is an environment where we continue to hear other chemical and material companies reduce their guidance and paint a pessimistic outlook. Yet for Ingevity, this quarter, we posted record sales, Adjusted EBITDA, and adjusted EPS.
Our Performance Chemicals segment saw record sales across its businesses in Engineered Polymers, Pavement Technologies, and Industrial Specialties. Performance Materials saw significant volume growth as global auto production increased during the quarter. Our consolidated results are directly due to our team's focus on attractive end markets, where customers require unique performance characteristics and where we can gain market share.
For example, with increased automotive production this quarter, our Engineered Polymers Capa business sold more higher-value products used in auto applications, such as paint protective film and jounce bumpers. Of course, higher auto production aided Performance Materials with significant volume growth in our activated carbon and carbon honeycombs.
Another end market where our products are experiencing strong demand is road construction. Municipalities are increasingly asking for sustainable performance-enhancing products like Evotherm, which lowers the amount of energy needed to pave roads while reducing harmful emissions. In the quarter, input costs, including energy, raw materials, and logistics, continued to rise, and Industrial Specialties volume was constrained due to lower availability of key raw materials.
By strategically focusing our product mix on derivatized products that bring higher value to both our customers and to Ingevity in markets like oil field, agricultural chemicals, and adhesives. Industrial Specialties was able to post a record sales quarter even on lower volume. In other businesses, we have experienced a lag between the timing of higher input costs and our price increases, either due to the speed with which the cost rose or due to the nature of our supply agreements.
These are timing issues that we'll correct as we adjust prices and represent expected upside into next year. We continue to generate strong free cash flow, and this allowed us to return cash to shareholders, pay down some debt, and continue spending on growth initiatives.
As we announced a few weeks ago, we completed the acquisition of Ozark Materials and are excited to have the Ozark family of specialty products to support this end market. Our integration efforts are moving forward and remain on track. They are a high-quality team and a great addition to Ingevity. There are tremendous opportunities for our teams to work together to better serve our customers with a broad array of products and technologies.
We were also pleased to announce the completion of one of our key organic growth initiatives as we finished the addition of caprolactone polyols production at our DeRidder, Louisiana site. We have been telling you about the demand customers have for our Capa polyols. Our polyols enhance high-performing end-use products, such as top coats on autos or planes, coatings on specialty flooring and boats, protective films, and footwear by making them stronger and more durable.
The addition will increase our global capacity by 40%. Before I turn it over to Mary, you all know that ESG is in our DNA at Ingevity. Our purpose is to purify, protect, and enhance the world around us, and we work to achieve this every day. As such, we were extremely pleased when we were awarded the Gold rating for corporate social responsibility by EcoVadis. This rating puts us in the top 3% of respondents in the specialty chemical sector. It is a reflection of who we are, what we do, and how we do it. With that, I'll turn it over to Mary to discuss the financials.
Thanks, John. Please turn to slide five. As you heard from John, we're very pleased with our third quarter results, with sales up 28% and Adjusted EBITDA up almost 16%. We delivered a record quarter on the top and bottom lines as our products and technologies continue to demonstrate their value to our customers due to their unique performance attributes and the sustainability benefits they deliver.
As we move down slide five, please note that we've excluded depreciation and amortization from gross profit and SG&A in order to provide more transparency to the changes year-over-year. A reconciliation to GAAP gross profit and SG&A is in the appendix. As you can see, our adjusted gross profit dollars were up over 21% year-over-year, driven by the higher sales, while our adjusted gross margin declined 220 basis points.
This decline was due to margin compression in both segments, driven by continued inflation impacting input costs. Similar to Q2, Performance Chemicals adjusted gross margin was negatively impacted by higher input costs and raw material constraints. The margin compression in Performance Materials was primarily attributed to the timing of raw material cost increases versus the timing of customer price increases, particularly in automotive.
We're beginning to see the pace of raw material increases moderate, and we expect to see our gross margins improve as that occurs. SG&A, excluding depreciation and amortization, increased about $12 million year-over-year as we continue to fund strategic growth initiatives and also saw higher labor related costs.
Our strong sales performance drove record Adjusted EBITDA of $138.2 million, up nearly 16%, while our Adjusted EBITDA margin was down about 300 basis points, due primarily to the combination of gross margin pressure and SG&A increase. Our quarterly diluted adjusted EPS of $2.09 is a record for the company.
Many chemical companies have commented recently on the negative foreign exchange impact to both their top line and bottom line results. As a global company, Ingevity saw some pressure on the top line from the strong U.S. dollar, which negatively impacted sales by about 2%. However, the impact of foreign exchange on our bottom line was not meaningful. We attribute this primarily to a combination of our diverse global sales mix and global manufacturing input footprint.
This is another area where our diverse end markets and geographies enables us to perform well despite market volatility. Turning to slide six, in the upper left-hand chart, you can see our sales through the third quarter have outpaced full-year sales in some prior years. You've heard us attribute much of the sales growth this year to pricing actions we've taken. I wanna emphasize that our ability to increase prices is not just a function of capturing higher input costs.
It's also a reflection of our success over several years in managing and upgrading our mix of sales to more diversified derivatized products and technologies that drive higher performance and value for our customers and for us, a win-win. For example, in 2016, about 1/3 of our sales came from lower-margin commodity products, predominantly in our Industrial Specialties business. Today, that number is cut in half to about 17%.
We will continue to focus on improving mix to drive value for our customers and for our shareholders. The upper right chart shows another quarter of strong free cash flow. As you can see in the capital allocation chart, bottom right, this allowed us to continue returning cash to shareholders through share repurchases, and we have repurchased over 2 million shares year-to-date while maintaining leverage within our 2x-2.5x target area.
We completed the Ozark acquisition October 3, so it is not included in these Q3 numbers. I will note, however, that we financed the $325 million purchase price with a combination of cash on hand and borrowings on the revolving credit facility. Our leverage will shift up in Q4, but should stay under 3x and be back in our target range in less than 12 months.
In summary, we delivered a strong third quarter, executing well on our organic and inorganic growth initiatives while managing to a balanced capital allocation strategy. Should the business environment worsen, we believe we are well positioned to manage through the challenges. Now I'll turn it over to Rich for more color on Performance Chemicals.
Thanks, Mary, and hello, all. Turning to slide seven, as John mentioned in his opening comments, the Performance Chemicals segment posted record sales across all three businesses in the third quarter. Sales of $337 million is over 30% higher than last year, driven by a product mix that was heavily weighted toward high-performance derivatized products, thus commanded higher prices.
This product mix helped offset what continues to be an inflationary environment for input costs and resulted in a record EBITDA of $77 million for the quarter, 22% higher than last year. Our Engineered Polymers team rebounded strongly from last quarter's unexpected downtime due to constrained raw material availability and ran the plant near capacity for the entire quarter to meet the demand for our polyols and thermoplastics.
Customer demand is strong for these high-performance products because they make end products more sustainable by giving them greater durability and resistance to wear and tear. In Q3, we continue to see strong growth in automotive as well as footwear and apparel, where the performance attributes of our products are appreciated.
One of the fastest-growing end markets for the Capa products is automotive paint protective films, where our polyols technology is incorporated to provide film with non-yellowing clarity, self-healing, and stain-resistant properties that can help keep vehicles looking showroom new and improve the resale value. Third quarter sales of $69.5 million was up over 31% from a year ago. Fantastic performance.
Our Engineered Polymers team has done an excellent job managing customer requirements as demand for caprolactone polyols continues to exceed supply, and they generated greater capacity by completing the polyols production facility at our DeRidder site in Louisiana, which, as mentioned earlier, has increased production capacity by 40%. Production commenced in September.
The first commercial sales followed in October. This is expected to support the future growth of these specialty products and geographic location, and the geographic location should help serve the customer base in this region as well as reduce global lead times. Turning to Pavement Technologies, Q3 sales of $88.3 million, an all-time record quarter, was up over 20% versus last year due to strong paving season.
During the quarter, we saw increased focus from municipalities on sustainability, which has led to increased technology adoption in both our Evotherm warm mix product and pavement preservation product lines. Evotherm enables paving at lower temperatures, extending the paving season, and reducing energy consumption, as well as overall emissions.
Our pavement preservation products save time, energy, and money by extending the life of existing roads. As you know, we closed on Ozark acquisition early in October and are extremely excited as we have begun working with the Ozark team to complement our existing Pavement Technologies products. We are working to leverage the strengths of our teams and processes to create synergies, such as utilizing the resin we produce in their pavement marking formulations. We expect to capture approximately $5 million of synergies during the next 18 months.
Industrial Specialties had a record quarter with sales up over 35% despite a host of challenges during the quarter. We experienced volume constraints due to raw material availability, which limited our production capacity as well as drove higher input costs. In addition, we saw certain customers choose to work down inventory levels as they assess the macroeconomic environment.
To meet these challenges, the team continued to focus on derivatized products, which allowed us to capture higher prices to offset increased input costs. We saw double-digit gains in agrochemicals, adhesives, and oil field, all end markets that demand high-performing products. Our technology teams are constantly working with customers to find new applications where our products can purify, protect, and enhance the world. In summary, Steve and I couldn't be more proud of the team and what they've delivered during the quarter.
Posting these results with all the challenges we face is truly an impressive accomplishment, and we want to thank everyone for their hard work. I will now turn the call over to Ed to discuss Performance Materials.
Thanks, Rich. As you can see on slide eight, sales of the Performance Materials segment were up over 22% to $144.9 million versus the prior year's quarter. This increase reflects the rebound in automotive production driven by improvements within the global automotive supply chain. Throughout the quarter, we saw sequential volume increases in each month within both our automotive carbon and honeycomb products.
Our sales into Asia-Pacific were up almost 40% versus Q2 of 2022 as volumes rebounded from COVID impact Q2 lows. Q3 North American automotive production was at the highest level since Q4 of 2020, and we're seeing signs that OEMs are rebuilding vehicle inventories. We were quite encouraged by our sales in Europe, which improved roughly 19% year-over-year as the availability of auto parts improved.
The EU is still working towards implementing a more stringent regulatory package for auto evaporative emissions, and we're expecting to hear an announcement before the end of the year. Our expectation is that the potential regulations in Europe would look similar to Brazil's requirements and could go into effect as early as 2026.
Our sales in Brazil are illustrative of the impact of more stringent regulations. While Brazil is a smaller sales footprint for us than other regions, our sales have more than tripled to last year. We expect continued growth in Brazil over the next several years as regulations are fully implemented. Segment EBITDA was $61.2 million, an 8.5% increase from last year. Segment EBITDA margin was 42.2%, down compared to last year, primarily as a result of increased energy and raw material costs.
We typically negotiate price with our auto customers annually early in the year. Although we increased our prices this year, particularly in the process purification market, the rising inflationary costs throughout the year have outpaced our automotive price increases that were implemented during Q1. I will now turn the call back to John to discuss the outlook for 2022 and for closing comments.
Thanks, Ed. On slide nine, you'll see our revised guidance. As we've said, demand continues to be strong, so we have raised the range of our sales and EBITDA guidance. We will also spend less in CapEx this year than expected, but we remain committed to maintaining safe and reliable plants while also investing in organic growth initiatives that bring value to the company.
As we look forward to the end of the year and into 2023, we are monitoring the broader economic environment. Much is being said about a potential recession in the coming months, particularly in Europe. Demand remains robust in our businesses. However, customers in a few markets, adhesives and certain Engineered Polymers customers, are signaling a focus on inventory destocking in Q4. It's unclear today if this destocking is short-term in nature or something more sustained.
At a high level going forward, we expect continued benefit from the recovery in auto production in both the Performance Materials segment and our Engineered Polymers business. With auto production numbers still low today, we should see them continuing to improve over the next several years, and we will benefit.
Additionally, we should benefit in our enlarged Pavement Technologies businesses as infrastructure spending continues to flow into municipalities for road construction and repair. Engineered Polymers margins have suffered due to energy costs, freight, and other material cost inflation in Europe. We are adjusting prices accordingly and expect to benefit into next year as their margins improve. For Industrial Specialties, while we face higher pine-based raw material costs and may see potential slowdowns in orders due to economic conditions, we see the benefits of the new regulatory-driven biofuel market for TOFA beginning to take hold.
Increased use of alternative raw materials to supply both the chemical industry and biofuel markets are also exciting opportunities for us to offset any recessionary pressures in our legacy markets. Finally, you'll see on slide 10 that we are planning to host an Investor Day event next spring. Originally, we planned to have it in December, but in an effort to increase transparency to you, the investors, we are in the process of evaluating how we report our businesses.
We didn't wanna have an Investor Day and then potentially change how we show and explain our business to you in the next quarter. We will complete our assessment and then hold the Investor Day early next year. We're in the process of rescheduling, and we'll keep you posted, but our goal is to give you all as much information as possible about Ingevity.
We look forward to sharing with you what we believe are exciting opportunities for us to continue to grow and further increase our profitability. We hope you will share our enthusiasm for Ingevity. With that, I'll turn it over for questions.
Thank you. As a reminder, if you would like to ask a question, press star and the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. We have our first question from the phone lines from John McNulty of BMO Capital Markets. Your line is now open.
Hi, John.
Thanks for taking my question, and really solid results. You know, I was curious on the Performance Materials business, I guess how far or can you quantify how far you might be behind on the price versus raws situation? I assume that catches up pretty quickly since you are the kind of big supplier in the industry, it catches up really quickly once you reset the pricing next year. Is that right?
Look, as Ed alluded to, we sort of do an annual price increase in that business, right? You will see us in early next year raise prices to our customers, and we will get back that margin. I don't really wanna quantify the exact hit because as you know, John, I mean, as we've always said, quarter- by- quarter, things can vary. We have outages, et cetera. Our intent will be to return to what we consider to be more normalized margins for that business, which are more in the mid-40s%, mid- to high 40s%, right? That is where we plan to go.
Got it. Fair enough. You know, paving, obviously pretty strong numbers, pretty strong numbers across the board really. I guess at this point, can you speak to, you know, how you're seeing 2023 lay out? It sounds like you've gotten a lot of incremental interest from the municipalities. I would assume some of this gets planned out a year in advance. I guess, can you speak to kinda how things are maybe starting to look for 2023?
Look, it's obviously a little early because these are annual paving campaigns. What I will say is as we move to the end of 2022, the weather remains pretty warm. As you know, when the weather remains warm, we're able to pave longer into the season. That bodes well for the end of this year. Into next year, I mean, we feel good about it, certainly in the U.S. with the infrastructure spending. We do expect that money to flow through. You know, we wanna sort of, let's see how we get to the end of this season and see what they sorta set up for next year.
Got it. Fair enough. Maybe I can squeeze one last one in just around Ozark. I know you haven't owned it particularly long. You know, can you kind of tell us what you're seeing right now, the overlap of that business versus your paving business in terms of customer base and how maybe you can leverage areas there, where one has a relationship and maybe the other doesn't?
Go ahead.
Sorry. No, go ahead. Oh, and also, I know there's extreme seasonality in this business, so just so we all kind of model it out properly, I guess, can you remind us of how that seasonality works, you know, as we look to 2023?
For sure. Look, the first off, Ozark is a fantastic addition to this company, right? It's a great group of people. We've all been out to see them, you know, been to all their sites here except for one in North America. Great group of people with a great business.
There are obviously a lot of opportunities for us. While you know, it is a different end product, the way we describe it to people is our customers are in the same building, if not in the same room, right? When we go to call on them. We have a great opportunity to leverage those relationships where they have strength and we don't, where we have strength and they don't.
Certainly as they look at things more international here in North America, whether it's Canada or into Latin America, we will bring capabilities to them that they don't have today. So it's pretty exciting for us. You know, from a seasonality perspective, it's really not that different from our legacy pavement business in that it's tied to weather, right?
You know, when snow hits the ground, it's pretty hard to paint, just like it's hard to do any road work. I would think about it in that regard. As you know, the vast majority of the profitability in that business, which can be in the 70%+ range, occurs in Q2 and Q3. You know, I think of first quarter and fourth quarter as sort of anchor shoulder seasons, right?
As I mentioned earlier, we're actually having a pretty good Q4 in that regard because the weather's been warm, but it's not like that every year, right?
Got it. Thanks very much for the color.
Thank you. Our next question comes from the line of Vincent Anderson of Stifel. Please go ahead.
Yeah, good morning. So, you know, it sounds like maybe I'm accidentally front running the new reporting metrics for next year. Given the volatility in Capa's input costs, you know, recently, but also, you know, very strong performance on the sales side, could you speak maybe just qualitatively about the trend in that business's maybe gross profit per pound or some other similar metric that gives us a bit more insight than, you know, just the consolidated segment margins?
Well, yeah. I mean, I guess the way to think about it, Vincent, I mean, you're correct. I mean, that business, because it's based in the U.K., is grappling with issues that are even more challenging than what we have here in North America, right?
Its margins have come under pretty significant pressure, while they've been able to actually see phenomenal demand increases for their product, right? Truthfully, I think they got a little behind in terms of their ability to keep up with the price increases, but I think we're gonna fix that, right? We've already started implementing price increases over there to recapture that.
I think speaking to your comment about lumping the segments, part of the challenge when they were operating as a consolidated segment is they didn't have as much visibility as we would like them to have into their cost structure, and we're gonna fix that, right? Look, we'll get their margin back over the course of next year.
Okay. Sounds good. You know, I was just curious what your read is right now on European biorefining of CTO. It looks like there's still just the same three plants that we know for sure are processing CTO, but just wondering if you had any additional insights into that market, if they're, you know, fully online. As kind of a, you know, as an aside, you know, how much pressure are you seeing on U.S. CTO availability with Russia now out of the European market?
Yeah, I mean, well, go ahead, Rich.
Well, certainly, thanks for the question. Certainly, that CTO market remains very dynamic. You know that globally there's about 2 million pounds of CTO, a million tons in the U.S. and same in Europe. There is about 200,000 tons coming out of Russia, but it's not coming out of Russia for all the reasons that we know.
Certainly to your first question, we continue to see additional production capacity come on within the biorefinery market and expect that to grow just based on the RED II initiative. Yes, the CTO, we are seeing inflation on the raw material there and expect to see that going forward. That market will remain very dynamic for the foreseeable future.
Okay. Perfect. Just one, hopefully a quick one on Performance Materials. Just curious what the areas of process purification are that you've had, you know, particular success in recently. You know, if that pricing power you referenced there is outperforming, you know, the traditional activated carbon, you know, competitive products.
Yeah. This is Ed. You know, the majority of our process purification revenue is in North America. You know, our process using sawdust and phosphoric acid.
Creates a unique pore structure that our competitive materials do not have. We are the only carbon manufacturer in North America that uses this process as compared to raw materials such as bituminous coal or lignite coal. The uniqueness of our process and products will give us some inherent advantage, performance advantages that the competitive carbons don't have versus our carbons. We obviously have an advantage in a number of areas, and we capture the value with our pricing.
Okay, thanks.
Thank you. We now have a question from Jon Tanwanteng from CJS. Please go ahead when you're ready, Jon.
Hello, John.
Yes. Hi, good morning. Hi, good morning. It's actually Pete Lucas for John this morning.
Oh, hello, Pete.
Hi. Just following up on Ozark, anything you can say to quantify any expected synergies at this point now that it's closed?
As Rich said, we expect roughly $5 million in synergies that we would capture over the next 18 months.
Great. Very helpful. Just jumping to any updates on Euro 6 and China 6 regulations and when they're expected to be finalized and implemented?
Yeah, this is Ed. You know, we're expecting an announcement in November from Europe around the regulatory package that they're putting in place. We expect it, as I said earlier, to be similar to what Brazil has, so ORVR with some diurnal emissions requirements, be it either 300 mg or 500 mg. I think are the two options that are on the table. We do expect an announcement in November and with some timing of adopting the regulations beginning around 2026 would be our best estimate.
I would also say, Peter, I think we should get this out there. I know that there were some rumors around a leaked copy of the new requirement, and it was circulated in some of the European papers and some write-up. The headlines do not reflect the reality as it relates to our business. When you read things like, "Oh, they're not changing it, they're gonna keep it the same," what they're really talking about is the tailpipe. If you read that leaked copy, and we're not commenting on its.
Veracity.
veracity or efficacy or what have you, but if you were to read it thoroughly, you would see that the emissions that are relevant for us, i.e., our EVAP emissions, are still in there, as are some other regulations that will be tighter around things like tires, et cetera. Just would put that out there for everyone. You know, we saw all that. We know those articles are out there, but they do not portray what will happen to our business correctly.
Oh, very helpful. Thanks. Last one for me, just if you could talk about what you're seeing in terms of M&A opportunity today from a pipeline perspective, or are you more concerned with integrating what you have and maybe doing other things with your cash?
Well, I mean, obviously we just closed on something, like, a month ago, so, right now, the near term, we're definitely focused on making sure we maximize the value between ourselves and Ozark. Look, our capital allocation priorities really haven't changed. I mean, obviously, to the extent we move into a recessionary environment, we do generate a lot of cash, and we have the ability to pivot that, you know, to protect our balance sheet as needed. Longer term, we're gonna continue to grow the business and we're gonna look at M&A and we're gonna look at, you know, continuing to return capital.
I will add to that. You know, M&A, as you know, it can be a long process. We had actually been looking at Ozark for quite a while before we brought that transaction to completion. You know, we're looking for good fit, good strategic fit, and has to be the right opportunity. We have a pipeline. We continue to manage the pipeline. We don't sit on our hands and, you know, wait to digest any acquisition. We're always looking, but we're balancing our leverage, cash flow, and making sure that the opportunity is strategic and a good fit for the company.
Extremely helpful. Thanks. I'll jump back in the queue.
Thank you. We now have another question from Vincent Anderson of Stifel. Please go ahead.
Yeah. Hi. Thanks for entertaining some more here. I wanted to follow up on that Performance Materials question that I left off with. I'm just wondering, you know, you've had a lot of success in moving, you know, production into that market, you know, obviously very aware of its advantages there, but automotive was always, you know, the cream of the crop.
As automotive comes back, you know, I think we've been saying that every year for three years, but let's say it comes back. You know, how are you thinking about balancing, you know, your allocation of capacity between those two businesses if you wanna kind of maintain a good relationship in the process purification space?
Yeah, Vincent, this is Ed. You know, obviously, what we'd be seeking for is where can we place our products for the highest value and the highest margin contribution to them, and we'll continue to do that. That is primarily our automotive segment and the honeycombs as well.
We do have some high value segments within our process purification, and we'll protect those, but there's some lower value opportunities where we, you know, produce product for water markets, which, you know, really help us from a contribution margin standpoint. We'd much rather be selling automotive products and other higher-end products that we've got into the market. You know, we'll easily walk away from water markets to swap out for automotive sales.
Okay. No, that makes a lot of sense. You know, we've talked about this in the past. I believe most of your participation in the biodegradable plastic space is more selling to compounders. You know, it feels worth asking. There's a very big PLA investment planned in the U.S. from, you know, like a mature supplier. Now that you've started to build out some capacity of Capa here, are there any thoughts around, you know, maybe an even more significant investment with a large, you know, offtake partner, you know, on the upstream side of the bioplastic space?
Vincent, we're not gonna. I don't wanna talk about, as you know, I mean, we've been pretty open with everyone. I mean, our stuff, we're very careful about specific customers that we refer to with this because, you know, we're a big part of their formulations and a part of their competitive advantages, so we don't wanna go into that.
What I will tell you is we are always actively looking at expanding capacity where customers need volume, right? We are looking at some point at doing another monomer or another monomer streamline. We just did the polyols in Louisiana. We will continue to invest and grow in that business as our customers need more volume.
Okay. Very fair. Just one last one, I promise, because you tipped your hand on what the price was. I had a coin flip between sulfuric and phosphoric acid. When you talk about recovering margins next year, obviously you have price power. If I'm not mistaken, phosphoric acid is already largely corrected back to pre-2022 levels, it looks like. Maybe just absent pricing activities, what's kind of the lag effect on when that will move through your margins?
Yeah. You know, we'll introduce pricing starting on January first. We typically try to help our customers so that they can recapture the costs. So as it is, you know, as you look at Japan, their fiscal year begins April 1 , and we'll have a price increase there as well, so that they can again make sure that they put the prices that we're putting in so they can recover them from their various suppliers.
One of the benefits we have, though, Vincent, as you know, is this is not a cost-plus type of business, right?
Right.
When we discuss price increases, it's typically tied to more than just one individual variable.
Sure. Okay. All right. Well, thanks.
Thank you. We now have the next question from Ian Zaffino of Oppenheimer. Please go ahead when you're ready.
We apologize, Ian.
Hi, guys. Thanks. How are you guys?
Ian, we apologize as well to you, Dan, and Mike. Somehow we love you, Vince, but somehow I didn't realize you could cut in line on a conference call. Go ahead, please.
Yeah, that's quite all right. Yeah, most of my questions have been answered, but just wanted to ask you on the paving side, and maybe this is a very difficult question to answer, but can you give us a little bit of color on, you know, paving and how much per se goes into, you know, single family homes and that area of the market compared to, you know, the other areas and maybe what you're seeing on both sides in both areas. Thanks.
Go ahead, Rich.
Yeah. Thanks. Thanks, Ian. This is Rich. The majority of our product does not go for single-family homes and driveways. Those are more commercial products that you see that you can get at a Home Depot or Lowe's. Most of ours is for highways and roads, and whether it's our Evotherm or our pavement preservation product, they're mainly on highways and roads and not on residential homes.
Okay. Thank you very much. I appreciate that and reporter again.
Thanks.
Thank you. We now have Daniel Rizzo of Jefferies. Please go ahead when you're ready.
Good morning, everyone. Thank you for taking my questions. With paving technologies, as you set up the contracts with the different municipalities, is there kind of like a take or pay component where they have to buy a minimal amount each year, regardless of weather or contract? Or how does it work?
Dan, this is Rich again. No, there's not a take or pay for the municipalities.
Okay.
They agree to a certain amount of product, and they use it as they need to pave various mileage of roads.
I mean, ultimately.
But they-
We basically, in a lot of situations, we have tanks on site that are metered and controlled by sensors. You know, we drop the tank, and they pull it as they need it, and they go as long as they can till the weather turns. When it needs to be refilled, we refill it.
They will buy a certain amount, though, I mean, for the contract. Like, they'll take the whole tank or two tanks or whatever they think is gonna be required. Correct? They don't. That doesn't change or does it?
Yeah. Well, they're able to tell us the kind of job that they're gonna be working on for that season, and then that job is then.
The formulation for that job is then developed on how much they're gonna need, and that's how they go about providing the product. Again, to your initial point, it's not a take or pay. It's just based on usage levels and what's gonna be needed to pave a certain amount of road.
Okay. You mentioned the $5 million with Ozark in synergies. I assume you're talking about costs over the next 18 months. Can you or have you quantified, and I missed it, any potential revenue synergies? You did say some of the clients were in the same building. Just, I apologize if I missed this, but if you could just kind of parse that out.
Yeah, Dan, we are right now focused on the cost synergies, and the number that we mentioned is cost-focused, as you say. The revenue synergies, we expect there to be revenue synergies. As you know, most people don't give a lot of credit for revenue synergies when you talk about them. They're harder to get and perhaps harder to find in a P&L. We feel really good about the package of opportunity that we'll be able to offer to customers and expect you'll hear more about that in the future. We will update you periodically on the cost synergies that we realize.
With Ozark and with your business, is there a long lead time for new contracts, whereas, I mean, it's gonna take a couple years for anything to be realized anyway, just because of the way the process works?
No, I don't agree with that. That's not really true, Dan. I mean, it's just that the issue that we run into with top line, and I share Mary's view, it's very subjective what is actually a synergy versus what is something that was just normal course business, right? We think there's opportunities for our salespeople to work together to complement each other.
There's opportunities for them to enter markets they're not in today to our salespeople. But we're not gonna look at it and call it a quote-unquote, "synergy." It's gonna be more sales growth as you move forward. What we're focused on is capturing the cost synergies, because those are real, tangible, quantifiable, and we can move the needle.
Okay. Thank you very much for that clarification. Go ahead, I'm sorry.
This is Rich again. I was gonna add. You know, we're very excited about, as John has already mentioned, the growth synergies, but that is the growth in terms of how the Ozark business can benefit from the extensive network that we have globally for our pavement business today.
Ozark is a North American company. Their products are done here in the States only, not necessarily, to some extent, in Canada, not in Mexico. If you look at our footprint, which is in Europe and South America and India, in Australia, there's a broader component to what we expect to do with Ozark portfolio that we're very excited about.
All right. Thank you very much.
Thank you. We now have Michael Sison of Wells Fargo Securities. Your line is open.
Hi there. This is actually Abigail Eberts along for Mike. Thanks for taking my question. Looking ahead to 2023 and a potential recession, I know you briefly touched on this on the call, but I was wondering if you could provide a little bit more color on how you expect your segments to perform in a potential recession. I know that, you know, auto production is expected to increase and that should be a tailwind for Performance Materials, but specifically Performance Chemicals with its industrial exposure, do you view that as a risk point?
Yeah, look, let us try and tell you how we're thinking about it. We obviously, this is what we do for a living. We think about these things every day. We wanna plan for the future, and we wanna be prepared if something happens, and we are prepared. From our perspective, though, we'll just kind of work our way through it, and you touched on some of it.
First and foremost, we're gonna see improvement in the auto production, predominantly because it's off such a low base, right? We will benefit from that in both our Performance Materials segment, but also in our Engineered Polymers segment. That will be an offset to what would be more of a broader industrial recession. We also have our Pavement Technologies business, right?
Which we've just actually bolstered in size. That business will benefit from the infrastructure spending. What we have seen in past recessions is governments like to turn on that type of spending because it shows their constituents that they're actually doing something and they're trying to create jobs, et cetera, et cetera. We will benefit from those in both of those sort of key end markets, right?
When you think about the legacy pine chemical business, we've actually been dealing with very, very large inflation for a couple of years now, right? We've been working very hard, as many of you guys have heard us talk about, to reposition that business. As Mary alluded to, you know, we've kinda cut our merchant sales or underivatized, commoditized type sales in half. Back in 2016, it was a third of our sales, right?
Probably not something that was broadcast or all that well known, but it was a large chunk back then. Today, we're down to about 17%. I also think that this economic softness will be different from the last one because in the last downturns, we had these issues in the far East that were sort of not market-driven, but more driven by a plant shutdown with regards to turpentine and what that did to rosin pricing, right? So that was a one-off. It's not gonna be a part of the equation, which is gonna take a lot of pressure off our in the next sort of downturn.
As we've moved away from these under-derivatized commodity products, and we've continued to broaden our raw material base, you know, look, some of our end markets are gonna soften, but we think we're in a good spot to counteract those and to be nimble and to push forward where we think we have opportunities to grow to offset that. That's how we're thinking about it. We're looking at it sort of market by market, and we're in position to to see how this plays out.
Okay. Thank you. Also just touching on raw materials. You noticed that you've seen 60% increases in some of your key inputs. Can you speak to which ones are the worst in terms of inflation? Are there any that are more resistant to coming down? I know you said some raws have been used recently.
Well, I mean, look, we, like every company, are seeing inflation in almost all of our raw materials, right? Our Crude Tall Oil has inflated multiples higher from where it was. You know, Engineered Polymers business and Performance Materials is seeing pressure in phosphoric acid, and energy costs are sort of cascading through all of our businesses.
Yes.
Logistics, freight, et cetera. It's hard to say that there's one that, you know, if it turns down, is gonna sort of change things, right? We manage each of them very carefully. We have dedicated supply chain specialists that work to manage each of those. Whether it's moving rail and truckloads and trying to get our costs down there, we have people that work on energy. We have dedicated buyers.
You know, we manage them, and we push price through to offset when we, you know, where we need to. We'll see what. You know, I guess what I would say is, while they remain elevated, they don't appear to be continuing to increase. That's probably a good thing.
Got it. Thanks.
Thank you. As a reminder, if you would like to ask any further questions, please press star then one on your telephone keypad. The next question comes from Christopher Kapsch from Loop Capital Markets. You may proceed with your question.
Hey, Chris.
Hi. Hey, good morning. I had a couple follow-ups. You mentioned some potential destocking in the pine chemicals segment, I believe, in non-derivatized product lines. I'm just curious if you were referencing more TOFA or rosin. Any color there would be appreciated.
Yeah, that's not exactly what we said, right? What we saw, we saw what we think could be some destocking in two very specific end markets. One is in adhesives, packaging adhesives, so pretty narrow, but we did see some destocking and some slowdowns there. Also in just a handful of our Engineered Polymers businesses, right? It wasn't. That's all we've seen so far, right? We're watching it, but that's really all we have seen as a company.
Okay. Well, I was just curious on the, then on the rosin side, well, for the adhesives end market. Is it enough to alter your, you know, your calibration in terms of your refinery run rates in the pine chemical business?
No.
Okay.
I mean, no, because you know, Chris, from where we sit, we're volume constrained, right? We get-
Yeah.
We can run it. What we can get, we're gonna run. We're a long way from that.
Got it. Yeah. Just to follow up on the inflation of feedstock costs, and again for the pine chemicals business. CTO, obviously a big one. Ever since the Georgia-Pacific acquisition, there was an energy component factored into your CTO costs, I believe. I'm just curious about the inflation. Is it more predominantly a function of this global supply-demand situation with CTO, or is there the potential that lower energy costs, and I'm watching WTI sort of coming back from peaks earlier this year, is there any potential that can ease CTO costs, or is that not really a thing given the global situation?
Well, it's an interesting question, and it deserves a longer conversation, right? Maybe we can talk about it in our follow-up. The truth of the matter is that the CTO is really being driven by global supply and demand for the marketplace, right? Regardless of what's really going on with oil. There is a correlation, though, to fuel, right?
You know, as fuel costs come down, you know, the value of a biofuel comes down. You know, it all sort of moves somewhat in tandem. You're right. As those pressures abate, that it would, it could there, in theory, put some downward pressure on CTO prices. But right now, it's a supply and demand game amongst, you know, all of us who use it.
Fair enough. Then lastly, just to follow up on your response to, you know, looking at, recessionary scenarios and the fact that, you know, there's no spike in turpentine prices. So should I interpret that as you're saying that the there's no real incentive for Chinese gum rosin producers to go after that natural turpentine, and therefore, there's not an oversupply, or you wouldn't expect an oversupply of that competitive material, the gum rosin? Thank you.
Well, it depends on how you define oversupply. As you know, what happened last time, because that turpentine plant went down, the Chinese went out and tapped trees to get at the turpentine and they got gum rosin as a byproduct, right? That's not the normal marketplace for that type of gum rosin.
That situation is in the rearview mirror. You know, it was at this point kind of two years ago. We don't see that happening. We think while you might see some pressure, because we always look at gum rosin pricing during the harvesting season, it will be more manageable than what we saw the last time. We also are managing it ourselves by staying away from sort of merchant sales markets, right? We're kind of attacking it from both angles.
Thanks, John.
Thank you.
Thank you. As we have no further questions, I'd like to hand it back to John for any final remarks.
Thank you, Brica. That concludes our call. Thank you for your interest in Ingevity, and we'll talk to you again next quarter.
This concludes today's conference call. You may now disconnect your line.