Ingevity Corp Q3 FY2020 Earnings Call

Greetings. Welcome to the third quarter 2020 earnings webcast and conference call. Please note, this conference is being recorded. I will now turn the conference over to your host, Jack Maurer. You may begin.

Thank you, everyone. Welcome to Ingevity's Third Quarter 2020 Earnings Conference Call. Earlier this morning, we posted a presentation onto the Investors section of our website. If you haven't already done so, I would encourage you to download this file so you can follow along during the call. You can find it by visiting ir.ingevity.com under Events & Presentations. For participants who are logged into our webcast, the slides should be visible in the online viewing pane and also available to download. On Slide number 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 the 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. 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 John Fortson, President and CEO and Interim CFO; Mike Smith, President of Performance Chemicals; Ed Woodcock, President of Performance Materials; and Bill Hamilton, Vice President of Financial Planning and Analysis and Treasury. First, John will comment on the highlights of the quarter and our impressive results despite the COVID weakened economy. Then Mike and Ed will review the performance of our two segments. Bill will discuss our current financial status and our recent senior note offerings, and then John will comment on our revised guidance and provide an overview of what we're calling Ingevity 2.0, a strategic approach to growth under his leadership as CEO.

Thanks, Jack. Good morning, everyone. Thank you for joining us this morning. We appreciate your continued interest in Ingevity. If you turn to Slide 4, you'll note some highlights for the quarter. Overall, this was a great quarter, particularly when compared to the challenges we faced in the second quarter. Revenues in the third quarter were $332 million, down only 8% when compared to the previous year's quarter despite the economic impacts of COVID-19. Ingevity's third quarter results were driven by strong returns in automotive sales and production worldwide versus a weak second quarter, along with continued strong paving activity in both North America and internationally. Cost reduction actions and strong execution also helped set several records in our performance. These positives were partially offset by a weakened economic environment due to COVID that particularly impacted our Performance Chemicals businesses, with the exception of Pavement Technologies, which held up fairly well in this environment. With respect to earnings, adjusted EBITDA were $128 million, up almost 12% from the previous year's quarter. This was an all-time quarterly record. The cost reduction initiatives we put into place resulted in a leaner cost structure and our ability to effectively execute helped partially offset the declines in volumes on a consolidated basis. Our adjusted EBITDA margin for the company was 38.5%, which was also an all-time quarterly record. For the fourth quarter, we also generated strong free cash flow of $73.5 million. I want to thank everyone on the Ingevity team for all their work over the last six months. We have navigated the ups and downs in both of our segments. The team in Waynesboro, Georgia, where we produce our honeycomb scrubbers continues to set production records. Recently, some of the leadership team and I visited our DeRidder, Louisiana pine chemicals facility. They have not missed a beat despite having to deal with two hurricanes and a tropical storm in an eight-week period. The plant continues to run even as many of our employees were without power at their residences for several weeks. Our performance this quarter is a testament to their efforts across the company. If you turn to Slide 5, you'll see the third quarter results for Performance Chemicals. At this point, I'll turn the call over to Mike Smith.

Thanks, John. As mentioned, our Performance Chemicals segment, with the exception of our Pavement Technology business, was particularly impacted by a weakened economic environment due to COVID-19. Overall, segment sales in the third quarter were $188 million, down 18% versus the prior year period. Sales to Pavement Technology applications were slightly higher than the prior year and set a quarterly record. While pavement sales in North America were essentially flat, sales in China and Europe, Middle East and Africa, EMEA, were up sharply, albeit from a smaller base. Projects planned by the majority of state Departments of Transportation in the U.S. continue to proceed as planned and are expected to progress on schedule for the remainder of the paving season. China's sales growth also benefited from low-temperature recycling technology we've been promoting there over the last two years, and growth in Europe was driven by our pavement preservation technology adoption in a number of countries. Sales for Engineered Polymer products were down due to reduced industrial demand globally. Footwear and medical device sales were also down with sales to bioplastic customers continuing to show growth. Bioplastic growth was particularly strong in North America as customers used Capa-based thermoplastics in specialty paper coatings and utensils. We anticipate improved sales to footwear and medical device applications when the impact of COVID-19 on retail sales and medical procedures abates. We continue to be successful in sales of our derivatized polyols and thermoplastics in this business. In fact, in the quarter, polyols and thermoplastics accounted for approximately 80% of Engineered Polymers revenue. Margins continue to remain strong, and given our raw material petrochemical link into benzene, we are realizing some benefits due to lower input costs. Sales decreased in Industrial Specialties across all end-use applications for products in this area. These include adhesive, printing inks, lubricants, rubber and paper chemicals. In addition, we continue to experience price pressure to our tall oil rosin products. That said, we are encouraged that the Chinese gum rosin export price has increased over 10% during the last month, a positive signal of improving supply/demand dynamics. Also, we are seeing positive potential in our agricultural chemicals business, where our ultra-stick and ultra-solve technologies for sustainable agriculture applications are progressing and have advanced the field trials with a number of our major customers. Additionally, sales to Oilfield Technology customers were cut sharply, in line with reduced drilling in North America. Sales in oil production applications were down moderately. That said, we are continuing to see wins in China and the Middle East as we work to diversify the geography of this business. Performance Chemicals segment EBITDA were $47 million, down 21% versus the prior year due to lower volumes. Reduced volumes and plant throughput were partially offset by price/mix impact and lower SG&A costs. We continue to control costs and generated a good mix of higher-profitability products, which resulted in our adjusted EBITDA margins remaining solidly in the mid-20s. We currently have an extended outage at our Warrington, U.K. facility for a planned monomer production glassware replacement project and have an upcoming outage in Q4 at our North Charleston plant as opposed to this outage occurring in the third quarter of last year. With that, I'll turn the call over to Ed Woodcock to review the results for Performance Materials.

Thanks, Mike. As you can see on Slide 6, revenues for the segment were up 10%. Automakers, particularly in the U.S. and Canada, rebounded sharply. As such, sales of our gasoline vapor emission control solutions have risen dramatically versus the second quarter. The industry continues to work to refill vehicle pipelines. In fact, U.S. vehicle inventory has been at a nine-year low for each of the last five months. With relatively strong vehicle demand, OEMs are struggling to refill dealer lots, and we estimate that this will continue into Q4. In the third quarter, vehicle sales in the U.S. and Canada were down 8.7%, and North American production was basically flat to prior year at plus 0.4%. The U.S. mix of light-duty trucks and SUVs versus cars has been at a record high mix of 77% since April. This high truck/SUV mix is favorable as these larger vehicles typically have multiple honeycombs on their canister systems. This contributed to strong demand for our honeycomb scrubbers used to meet U.S. and Canadian regulatory standards. The team at our Waynesboro, Georgia facility continues to work hard. And in response, they set a quarterly record for honeycomb production. Sales of Performance Materials products in China continued to show strong growth sequentially and versus prior. July and August vehicle sales and production continued the trend that began in April, where both sales and production are at or above prior year levels. July's vehicle sales and production were up 13.8% and 18.3%, respectively. August continued the year-over-year trend with sales and production also up 9.5% and 3.8%, respectively. September data has yet to be posted. Lastly, the implementation of the China 6 standard has been completed. Segment EBITDA were $80 million, up 48% versus the prior year period. Segment EBITDA margin increased 1,430 basis points to 55.9%. We benefited from a strong improvement in volumes that leveraged our low variable costs, favorable price/mix and plant spending and lower legal costs. All of our facilities are back to running at their normal rates, and we expect no furloughs for the remainder of the year. In October, we began a 35-day kiln replacement outage at our Covington, Virginia facility. This completes the last of four kiln replacements at that facility. At this point, I'll turn the call over to John.

Thanks, Ed. Many of you on the call have met or spoken with Bill Hamilton, our Vice President of FP&A and Treasury. Hopefully, you also saw that last week, we priced a high-yield bond at 3.875% and also amended and extended our bank deal. Bill was the architect of both of those transactions. So I would like him to speak to our capital structure at the end of Q3 and also what it looks like now going forward. Bill?

Thanks, John. I'd now like to discuss our capital structure, which you will find on Slide 7. Our borrowing rate at the end of the quarter for our revolver was LIBOR plus 150 basis points, and the borrowing rates of our term loans are LIBOR plus 100 and LIBOR plus 150 basis points. Of the term loan, $166 million has been hedged in euros to be fixed at 1.35%. The rate of the senior notes issued in January 2018 remains fixed at 4.5%, and the $80 million industrial revenue bond borrowing rate remains at 7.67%. The resultant weighted average interest rate was approximately 2.6%. Net debt as of September 30 was $1.032 billion. Our net debt ratio was 2.73x, which is down from the second quarter when it was 2.96x. Trade working capital for the quarter decreased slightly from the previous sequential quarter to $273 million, which is 23% of sales. With regards to our capital allocation, given recent events and the impacts of the coronavirus on our business, our priorities have shifted somewhat. We are focused on returning to our long-term target net leverage between 2.0x and 2.5x. That said, if and when the market stabilizes, we will be opportunistic for share repurchases going forward. Before the full scope of the coronavirus impacts were known in the first quarter, we did repurchase shares, and we have $467.6 million remaining on our current share repurchase authorization. While we continue to examine M&A opportunities, we are weighing those in light of the above preferred uses of capital. Additional information will be available in our Form 10-Q, which we expect to file later today. Turning to Slide 8. I'd like to provide some information regarding our updated capital structure. Last week, on October 20, we undertook a two-part transaction that included an eight-year $550 million senior unsecured notes offering at 3.875% and an amendment and extension of our revolving credit facility. When evaluating our capital structure, which was heavily weighted towards secured debt with 2022 and 2023 maturities, we took an opportunistic approach and waited until unsecured debt at a rate below 4% was available to us. The proceeds of the notes will be used to repay our inside term loan agreement due in 2022 and the remaining $170 million outstanding on our revolver. Additionally, we downsized our revolving credit facility from $750 million to $500 million and extended it by just over two years to October 2025. In aggregate, these moves extended our debt maturity schedule to 5.8 years, an extension of almost three years. While this transaction is slightly dilutive to earnings per share, it secures a low-cost and flexible capital structure for the next several years. Additionally, we have a call on our existing 2026 senior unsecured notes in February 2021. By calling a portion of these notes, we can counteract some of the dilutive nature of the new issuance. I will now turn the call back over to John.

Thanks, Bill. Turning to Slide 9. I'd like to review our revised guidance. We have narrowed our fiscal year 2020 guidance for sales from between $1.1 billion and $1.2 billion to between $1.15 billion and $1.2 billion and increase and narrowed our guidance for adjusted EBITDA from between $310 million and $350 million to between $355 million and $365 million. This indicates we are above what we previously characterized as the high scenario of our guidance. Performance Materials sales and margins will normalize in the fourth quarter. However, full-year EBITDA margins for the segment will increase somewhat from last year. This will be offset by weakness in the Performance Chemicals segment. We'll be controlling our capital expenditures and still plan to spend about $85 million, almost all of that on maintenance. As such, we expect free cash flow for the year to be greater than or equal to $175 million. This exceeds the free cash flow of $161 million that we achieved in 2019. And we expect to end the year at a net debt to adjusted EBITDA ratio of less than or equal to 2.75x despite lower EBITDA for the year. We remain confident in our business through the end of the year. While we may see continued weakness on the revenue line, given the cost controls we've implemented and the favorable mix of sales across our segments, we expect our adjusted EBITDA and adjusted EBITDA margins to remain favorable. And while uncertainty remains regarding global economic strength, we believe in the strength of our strategy and our team's ability to execute on the opportunities. Turning to Slide 10. I'd like to step away from the numbers for just a moment to provide some perspectives on our future and share our plans for Ingevity 2.0, which is how we are referring to a refined approach to our growth moving forward. In order to understand what we mean by Ingevity 2.0, I think it's important for us to first understand what we've accomplished in the past or under Ingevity 1.0. Since late 2015, we've focused on executing our spin-off from WestRock as a stand-alone publicly traded company in May of 2016. In our first five years, we needed to ensure that we executed on the opportunity provided by the significant step-up in automotive regulatory standards in both the U.S. and Canada and then in China. And we did. The growth of our Performance Materials segment has been remarkable as a result. At the same time, on the chemical side, we've driven up margins for our Performance Chemicals business from 13% to 23%. We've made substantial progress in organizing around our sustainable roots as a company and are beginning to quantify the impacts of our products on the environment. We believe that in our first phase as an independent company we've established ourselves as a leading specialty chemicals company with top quartile financial metrics. Moving beyond Ingevity 1.0, we are not revising our fundamental vision, mission, values or strategy. That said, 2.0 represents a new way of approaching our vision and strategy. We expect to do this by leveraging our inherent strengths in building technology-based customer partnerships that deepen our relationships, create greater value and drive increased growth and profitability for our customers, ourselves and our stakeholders. We'll continue to focus on high-margin derivatized products that provide outsized performance and value to our customers. Over our 100-year history as a business, we've developed a solid reputation for innovation. We have the opportunity to build on this to drive organic growth. And while we inherently know that we are a sustainable enterprise, we want to use sustainability as a competitive advantage. Lastly, there are a number of macro trends that we believe are in our favor going forward. So turning to Slide 11, let's take a look at those trends. First, we believe that the global focus on sustainability and quantifying a company's total carbon footprint has only just begun. While we've inherently known that we are a sustainable company, we have not quantified or communicated that to the degree that we should to either our customers or shareholders. That will change. Seventy-seven percent of our products come from renewable resources. That is a staggering number for a chemical company. Our customers are working to decrease their carbon footprint. We have a unique differentiated opportunity to work with them to solve their issues with our chemistry. Second, more and more governments, both within the U.S. and internationally, are looking to regulate environmental health and safety issues. We believe our products in many instances are uniquely suited to solve those issues. One example of these types of opportunities is in the area of biofuels. Our assets, our people, and our facilities are uniquely positioned to look at a variety of feedstocks that could be used in this market as well as in other traditional chemical applications. Lastly, we're going to leverage the trends related to renewable gas and accelerate our work on adsorbed natural gas or ANG technology to provide ultimate sources of demand for our carbons outside of our traditional focus on internal combustion engines. With that, let's turn to Slide 12, where I'd like to focus on the three areas where we will strategically focus our growth moving forward. By placing greater emphasis on sustainability, customer centricity, and innovation, we expect to grow our company's revenue and profitability. For those of you who have been following us over the last year, especially earlier this summer as part of our sustainability-focused investor webinar and the release of our latest sustainability report in August, you understand that sustainability isn't a new concept to Ingevity. We have a long history dating back through our predecessor companies of managing the business with environmental, social, and governance principles in mind, and it's inherent just by the nature of the products we make. As I mentioned, seventy-seven percent of Ingevity's revenue comes from sustainable products. But more importantly, sustainability is woven into the fabric of our culture and our mission to purify, protect, and enhance the world around us. We intend to continue to further quantify our brand promise. The initial greenhouse gas impact studies we recently completed for our Nuchar and Evotherm products are only the beginning. Our goal is to complete an initiative to quantifiably evaluate the societal benefit of our significant product lines by 2022. We intend to embark on an aggressive certification program, whereby our products are recognized for their renewable nature by a variety of recognized third-party experts. We believe this will be a value to customers. We also intend to take the success we've had in Performance Materials around gasoline vapor emission control and expand our regulatory advocacy to benefit other product platforms such as our paving applications. In terms of customer centricity, we expect to broaden and deepen our already strong customer relationships. When we work side by side with our customers on technologies that solve problems, we achieve a level of stickiness within our customers' formulations. As the world emerges from 2020 and its challenges, we see this as an opportunity to expand the use of our engineered polymer products. We also have significant opportunities around the world in addition to the use of caprolactones, but also for our oilfield and pavement products, where we can expand. We are already investing in an SAP HANA upgrade and best-in-class technology that will enhance the efficiency of our interactions and transactions with our customers. Lastly, we will focus on innovation. We are looking across our businesses for innovation opportunities. As I said earlier, we're going to accelerate our efforts on ANG. In addition, we're going to focus on identifying applications beyond automotive that can benefit from our activated carbon's unique ability to capture and release vapor molecules. This is just one example of where we think opportunities exist across our portfolio. We are not constrained by our current or historical products or customers but instead are looking at where technology, regulatory, and market changes are creating opportunities. From a capital allocation standpoint, our focus remains on growth with more emphasis on extracting maximum value from our current assets. We intend to remain a high margin, high free cash flow generating company that will provide us the opportunity to both invest in our future but also return capital to shareholders if appropriate. Hopefully, this gives you better insight on what we mean when we say Ingevity 2.0 and where we intend to take this company in our next phase of growth. These continue to be unprecedented times from a business standpoint, and we are incredibly pleased with our performance this quarter and year-to-date. More importantly, given our track record on guidance and meeting guidance, we remain optimistic and confident in our guidance for the full year. We also believe that we're well positioned for value creation in the long term. As a market-leading global specialty chemicals company, we continue to leverage our technical expertise to the benefit of customers. Combined with a strong balance sheet and experienced management team, we believe in the soundness of our strategy and our ability to execute on the many opportunities in front of us. In closing, I appreciate the work and efforts of our 1,850 employees worldwide. They are a distinct competitive advantage for us. We continue to believe very strongly in the long-term potential for our company, and we hope you share our enthusiasm for Ingevity. At this point, operator, we'll open the call up for questions.

Our first question is from Ian Zaffino with Oppenheimer.

Great. Wanted to maybe focus on materials. And I guess you saw some really nice pricing there. Where was that pricing, maybe what region you saw that in, maybe what was the driver of that? And then I have a follow-up.

Ian, good question. Thank you. Price was global, mostly focused with our larger markets of NAFTA and China.

Okay. Has that type of pricing now reached a baseline? Is there more opportunity for growth? Additionally, regarding demand, how much of the demand or volumes were related to refilling the pipelines versus actual underlying demand?

Yes. For your first question, we historically have been putting price into our products over many years, typically averaging anywhere from 2% to 5% on an annual basis. We feel we'll continue to move price each year and obviously try to capture price wherever we can around the globe. From a demand perspective, volume was increasing in China as they fully implement China 6. So we saw good year-over-year demand in that region in addition to the strong growth of sales that are happening in that region. And then NAFTA as well with the rebound from Q2, we saw good demand, solid demand for our products and solid demand for the OEMs' products, which cascades down to us as well.

And our next question is from John Tanwanteng with CJS Securities.

It's Pete Lukas for John. Just one on the pavement side. How dependent are you on federal stimulus shoring up state budgets in terms of your outlook for 2021 there?

Well, federal spending, clearly very important, and there has been a one-year continuation on that. Like a lot of areas of the federal government, there's certainly some uncertainty in terms of the priorities and execution as we get into next year. But we're very optimistic that with all of the focus on infrastructure projects across the board of federal government that they're going to get behind further increasing infrastructure spending. I think that in time, that should be - continue to be a favorable tailwind for our Pavement Technology business.

And just one more for me. In terms of the outlook for oilfield at this point, how does that figure into your margin or earnings growth story over the next year or so?

Yes. So Pete, at this point, we are, like most people, just looking at what the industry experts are indicating for future oilfield pricing and level of drilling activity in this current weak demand market. So we are not, at this point, projecting a significant turnaround in that until we start to see overall global demand pickup for oil - in the oil industry. So it will come, but we're not calling the timing of that yet.

Our next question is from Mike Sison with Wells Fargo.

This is Richard on for Mike. So great performance on the margin side this quarter. Just wondering if you could give some color around Performance Materials and the 56% margin. How much was that related to the return of facilities back online versus cost cuts and then price and mix? And how does all that play into it?

Yes. Richard, as I talked during my script, there's a good mix of vehicles in North America right now that is driving additional honeycomb demand. We're also seeing good trucks, SUVs with multiple honeycombs helping to push that price/mix for us. The other mix is, again, in China, where they're implementing the China 6 standard and previously with a much smaller canister with lower content of regular carbon in those canisters shifting to higher content, higher volume, and also shifting to pellets. So we had a good strong mix change there as well.

Richard, I believe investors often overlook the high fixed cost nature of this business. Comparing Q2 to Q3 illustrates this well. During the global auto shutdown, which lasted about six to eight weeks, we maintained margins around 25%, which is quite strong for our industry. This clearly shows the impact of those tough times. Conversely, in a robust quarter like Q3, where operations are running at full capacity without significant disruptions, you can really see the potential benefits of our high fixed costs.

That's why we look at margins in this business on a year-to-year basis rather than on a quarterly basis.

That's correct. It's important to note that in Q4, there will be some downtime. While the outlook appears positive, we anticipate that it will begin to normalize. Achieving an increase in segment margins year-over-year in a situation where we experienced global downtime for six to eight weeks is quite impressive.

Definitely. But I guess in terms of longer term, what would you say our normalized margin is? Is any of that cost reduction coming back next year? I mean 41% was the margin last year, but...

We are not providing guidance for 2021 at this time. However, we have mentioned that there are some unusual shocks affecting the system in 2020. Therefore, I don't want to directly compare 2021 with 2020. Looking ahead, we anticipate that our margins will continue to improve. While we are not ready to discuss 2021, since starting this journey in 2016, we have demonstrated consistent growth, and we expect that trend to continue over the next few years, keeping in mind that 2020 has been an exceptional year.

Okay. Got it. And then on Performance Chemicals, obviously, still seeing some weakness, Engineered Polymers and Industrial Specialties. How much of this was COVID-related, specific? Is there any way to quantify that?

Yes. Thanks, Richard. I don't have an exact quantification of it, but the COVID impact on those two businesses has been significant. Let me just take each of them a little bit because they are somewhat different. In Engineered Polymers, we saw a particularly kind of large drop-off in the third quarter as inventory was removed throughout the value chain from our customers and their customers. We didn't see anywhere near the drop-off in the second quarter as a lot of businesses did when COVID first hit. That said, we're optimistic. The recent orders as we exited September and got into October on Engineered Polymer side are really trending positively in a good direction. We look forward to that continuing. In Industrial Specialties, the COVID impact has been broad in many areas. We have general industrial weakness. Then we have certain areas - and I'll just bring up ink as a specific example, where the COVID impact on the retail market and malls being down led to companies not printing circulars that use the types of inks that we offer, which has been extremely dramatic in the second and third quarters. As that situation abates and people return to a more normalized life, that situation won't be nearly as dramatic.

Our next question is from John McNulty with BMO Capital Markets.

So you highlighted the strong cash flows that you guys have generated kind of putting you in a position to actually refocus capital maybe away from debt reduction and into either M&A or buybacks again. Can you speak to if you have a preference at this point? I mean obviously, your stock has been under a lot of pressure. Yet at the same time, there does seem to be a focus by the market on growth, and growth can come inorganically as well as organically. What are your thoughts on capital deployment? And also, any color on the M&A pipeline that you may have been developing?

Yes. So John, I appreciate the question. I mean look, it doesn't take a rocket scientist to sort out that we will probably be in our target 2x to 2.5x leverage ratios at some point early to mid-next year. We're on that trajectory. We do view ourselves as a growth company. We are looking at growth opportunities. I would sort of suggest that in this environment, they're more internally organically focused than M&A. You can never stop looking at M&A, but I think in this environment, the challenge is getting a buyer and a seller to agree on a five-year forecast and also figuring out what multiple you're going to pay. I just think the typical deal flow is hard right now. Most of the deals you see being announced are those in the works for a while. I view our swapping out a little bit of money that might otherwise have gone for M&A being plowed into our internal organic growth. We have demonstrated that we will buy back shares, and we have the authorization. It's always on the table when we look at our cash generation versus other places to deploy it. Both things are being looked at pretty carefully.

Got it. Fair enough. Regarding the growth opportunities, you mentioned natural gas containment. Is that related to the pilot programs you were running for fleets using natural gas for vehicles? Can you provide an update on those pilot programs and whether we can expect them to generate revenue in the next 12 months?

John, this is Ed. You're correct. We do have a number of pilot programs underway, principally in Pennsylvania based on some credits and AFV credits available for natural gas vehicle conversions. Those pilot programs are expanding. I don't want to get ahead of the business itself, but we see good demand and efficacy of the product as a whole. We continue to look at that whole business as favorable for creating another business segment over the long run. In the short term, we still have investments to do, and we're continuing to drive greater commercialization across the platform. It's a bit early to declare success on it, but we feel it's got a lot of great legs in front of us.

Got it. And if I can maybe ask one last question. In terms of some of the big focus from an ESG perspective from the regulators, it does seem like things have quickened pretty quick over the last six to nine months. And a lot of stimulus is tied to more green initiatives, etc. When you look at the opportunity for new gasoline vapor emission standards, do you have any greater confidence in new standards coming in, whether it's in Europe or China? Or is it too early to tell at this point? Can you speak to that for us?

Yes, not a problem. We've talked about this a bit over our webinar over the summer. We see regulatory changes impacting us over the next five to seven years. Brazil has already promulgated regulations, and they'll move forward with that starting around 2022 to 2023. China is looking at a China 7, which would be more Tier 3-like with the U.S. That's likely around 2025, plus or minus a year. And then Europe is also looking at regulatory requirements to start controlling refueling emissions. COVID had a large outcome as they looked at environmental issues in Europe when the industry was shut down, NOx decreased significantly, but VOCs increased significantly. Those VOCs were caused by gasoline-using vehicles that were idle, contributing emissions to the atmosphere. We feel it’s driven the European organization to take actions to capture those VOCs, and we believe it's going to drive additional regulatory components into that market.

Our next question is from Daniel Rizzo with Jefferies.

You mentioned Pavement Technology is doing well in China and Europe. I was just wondering how much of the sales are from that region within that subsegment?

In general, we've got 80% are still in North America. The remainder, 20% is largely from Europe. Obviously, within Asia, China is the largest piece of that.

Is Evotherm helping drive the growth in those regions? Or is it more just traditional products?

Actually, in the global markets, Evotherm is gaining traction and starting to be adopted but is not significant yet like it is in North America. The growth we're demonstrating here is more from traditional products, mostly on the pavement preservation side or some emulsifier technology that's been adopted in coal recycling in China.

All right. And then just one final question. You mentioned some kiln replacements and some outages, I think, in the third quarter. I was wondering how much of that, if any, is pulled forward from 2021, whereas you're doing it now because of the current environment and it won't be necessary for next year or the year after?

Yes, Dan, we actually had that kiln outage at our Covington facility scheduled for Q2. Due to COVID, we delayed it to Q4. We effectively got 15 to 20 more years before we have to replace a kiln at that plant.

On the chemicals side, the Warrington upgrade for the glassware project was originally planned for Q2 due to COVID. We've moved that, and that's underway currently. The outage in the North Charleston plant has always been a planned outage for Q4.

It seems a little bit counterintuitive, Dan. But part of the challenge is there's obviously two different situations in each segment. But in a COVID environment, where you've got contractors running around your plants interacting with your people, it slows things down a little bit.

And our next question is from Chris Kapsch with Loop Capital Markets.

A couple of questions focused on the PM segment. You mentioned lower legal costs is one of the contributors to the higher margins in the quarter. So I'm curious, I assume it's right to assume that 100% of patent litigation costs are allocated to the PM segment. Wondering if the lower legal expense in the third quarter reflects any shift in strategy or merely just a timing consideration related to the dispute process timeline?

Yes, Chris, this is Ed. It's more around the timeline of litigation. We expect a little bit higher legal costs in Q4 as we get to a trial occurring in Q1.

Okay. And then I guess this is a patent dispute over the IP that's expiring in a couple of years now. With respect to when those patents expire, speaking to the patents around the honeycomb application for Tier 3 emission standards. You provided some scope about how, if you extrapolate what the automotive end market is going to look like in that timeframe, there's the shift towards low-purge engine technology. That could comprise as much as two-thirds of auto sales. Just at this point, if the automotive OEMs are still going in that direction, you probably have visibility on that platform. So I'm just wondering if there's any sort of visibility on how the automotive OEs are proceeding with that strategy?

Yes. Chris, we do see that trend continuing towards our new low-purge patents. A particular product we sell indicates a good need for capturing VOC emissions from the canister in low-purge environments. We still think that those low-purge platinum systems are going to capture anywhere from 30% to 70% of the vehicle market. As we continue to see each month and each quarter, we're seeing greater utilization of particular products of ours that indicate that the low-purge strategy is indeed coming into effect.

Okay. And then just finally, one quick one on the fourth quarter deferred kiln turnaround in Kentucky. Is there any way to quantify the impact that may have on that segment in the fourth quarter in terms of cost?

Yes. Chris, we'd estimate somewhere between $4 million to $5 million.

And our next question is from Paretosh Misra with Berenberg.

Can you just remind us where we are in terms of U.S. Tier 3 adoption? Is there any incremental that's left for next year? And also, what's the latest that you are hearing on new regulations in Brazil?

Yes. Paretosh, for the U.S., they are effectively required to have 100% implementation by the 2022 model year. If you think about it, they are making those 2022 model years now, so we're seeing ongoing purchases of honeycombs and completion of platforms to finish it up within the next several months.

Got it. Okay. And then just a quick follow-up on this outage at Covington. Can you remind me what exactly you make there? And while that factory is down, can you make those volumes elsewhere? Or did you just build inventories in anticipation?

Yes. No, we built inventory in anticipation of that outage. It was a cold outage for basically 35 days. As the plant comes back online, we'll obviously be restocking our inventories.

Understood. And last one for me. How are you affected by exchange rates? Is a weak dollar a good thing for you?

Yes. A weak dollar is better for us.

Our next question is from Jonathon Luft with Eagle Capital Partners.

And first of all, John, congrats on the new role. I think the Board made a great decision naming you CEO.

Thank you.

So my first question, maybe if you could just talk a little bit about the competitive environment in Performance Materials. Are you seeing anyone new or any new emerging competitors either in the U.S. or, more importantly, in China?

Yes. Jonathon, this is Ed. I'd say it's kind of relatively the same as it has been over the last five years. No new entrants and current players are still in the marketplace.

Okay. Great. And John, I was hoping you could talk a little bit more about the ability for Ingevity to use sustainability as a competitive advantage. Is it something specific that you are trying to address there? Is it something customers are coming to you for? Or is this your own initiative? How does this benefit you?

Yes. Look, if you think about it and take a step back, our products come from oil, but it's an oil that comes from trees. Historically, we've always competed in the marketplace based on price and performance characteristics compared to hydrocarbon oil-based products. There’s also competition from gum rosins. However, for the first time in my professional career, clients and customers are asking questions around the renewable nature of the input because they want to reduce their GHG footprints. We’re in a good place with our products because of their origins. What we are learning is that if you don’t go through the processes of certification, you don’t get credit in the marketplace. We’re in the process of doing that, which will allow us to engage our customers more on the benefits. I think the renewable nature will be evaluated as a performance characteristic along with other factors in the market.

Our next question is from Chris Kapsch from Loop Capital Markets.

Yes. I had a follow-up focused on the pine chemicals side more. You mentioned that Chinese gum rosin prices have increased. When turpentine prices normalized, I guess the producers weren't pursuing that as hard. I'm wondering if the current improvement in gum rosin prices is supply-driven? Fewer trees being tapped because of COVID, or is it more a demand function?

Yes, sure, Chris. It is primarily supply-driven. There has been a reduction in production in China. This has been an ongoing trend as tapping trees is highly labor-intensive. While turpentine prices were high, there was motivation to do that. Now supply has been curtailed, and there was also inventory throughout the chain that has been worked through. We've seen quite a nice increase, over 6 weeks it’s been 15%. Pricing is now back to levels we haven’t seen since the end of 2018. It’s been a long slog, and we’re encouraged by the turnaround. We know that Brazilians are competing in that market, so we’re hopeful that the entire market will get back to more acceptable prices. If Chinese gum rosin prices stay high, we should be able to get a pricing turnaround. It may not be instantaneous, but we’re conditioning the market now. As we enter next year with a sustainable supply/demand picture, we expect overall pricing environment to improve.

Got it. And then the follow-up would be on those conditions; is that enough to anticipate maybe an upward bias for what has been an otherwise beleaguered TOR rosin price environment over the last couple of years?

Well, the TOR market is still tough at this point. However, if Chinese gum rosin prices remain high, we can expect to see a pricing turnaround, it may not be instantaneous, but we are working on it now to condition the market. As we progress into next year with a sustainable demand, we hope to see the market return positively.

We have reached the end of the question-and-answer session. I will now turn the call over to Jack Maurer for closing remarks.

Well, thank you for dialing in, everybody. We appreciate your interest this morning. We remain very positive about our long-term business outlook, and we look forward to talking with you again next quarter.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.