Ingevity Corp Q3 FY2021 Earnings Call

Greetings. Welcome to the Ingevity Third Quarter Earnings Report. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to Bill Hamilton, Treasurer and Head of Investor Relations. Bill, you may now begin.

Thanks, Rob. Good morning, everyone. Welcome to Ingevity's third quarter 2021 earnings conference call. This morning we posted a presentation on our investor site that you can use to follow today's call. It can be found on ir.ingevity.com under Events & Presentations. Any projections or goals we may include in our presentation today are likely to involve risks we've detailed in our earnings release, our SEC filings and the forward-looking statement you see here on slide two. I'll also refer you to our earnings release and presentation for disclosures and reconciliations of non-GAAP measures we use when discussing our results. Our agenda is on slide three. With me today are John Fortson, President and CEO; Mary Hall, our CFO; Mike Smith, President of Performance Chemicals; and Ed Woodcock, President of Performance Materials. First John will comment on the highlights of the quarter. Mike and Ed will review the performance of our two segments. Mary will comment on our current financial status. And lastly, John will discuss our revised guidance for the year. With that, I'll turn the call over to our CEO, John Fortson.

Thanks, Bill, and good morning, everyone. Thank you for joining us. If you turn to slide four, you'll note some highlights for the quarter. Overall, I'm really proud of the way Ingevity has performed this quarter. We continue to grow many of our current businesses in the face of raw material inflation and supply chain headwinds, while also advancing our new product initiatives. Sales in the third quarter of 2021 rose 14% to $377 million compared to the previous year's third quarter. Our third quarter results were driven by significantly higher Performance Chemicals volumes and Engineered Polymers and Industrial Specialties and were supported by price increases across the segment. Engineered Polymers saw increased volumes in Q3 for all product lines. This business has demonstrated robust growth throughout 2021. Our Industrial Specialties business also delivered very good performance on increased demand. And sales of our Pavement Technologies products were slightly ahead of the prior year's third quarter. The prolonged impact of the global microchip shortage continues to depress automotive production, which negatively impacted sales of our activated carbon in our Performance Materials segment. As a result, Performance Materials sales and adjusted EBITDA were down compared to 2020's third quarter, which is a tough comparable period. This was the quarter last year when demand and production rebounded sharply from pandemic lows. With respect to Ingevity's consolidated earnings, both our adjusted EBITDA and adjusted EBITDA margin were down from third quarter 2020 due to margin compression caused by the impact of lower sales in our Performance Materials segment. However, when compared to the more normal year of 2019, margins were essentially flat on EBITDA that grew almost 5%. You will hear more from Mike and Ed as we continue to advance important initiatives across the company that are positioning us for long-term sustainable growth. We had our first commercial sales of TOFA into the European biofuels market, an application we anticipate will represent a significant opportunity for us in the future. We have obtained certification for biofuel sales at our North Charleston plant and the process to expand it to DeRidder and Crossett is well underway. We are working to advance our soy-based fatty acid production capacity at our Crossett facility, with a goal of significantly more capability in the second quarter of 2022. We are finding increasing market opportunities for this alternate feedstock. We are also expanding our monomer production capacity of caprolactone in Warrington to meet the higher levels of demand for our products and our plans to add polyol capacity at our DeRidder plant are on track for Q2 of next year. Our products are even finding their way into the electric vehicle value chain. Our Industrial Specialties team is selling products to support lithium mining operations and our Engineered Polymers Capa products are used as critical performance-enhancing materials in electric vehicle battery pads to dampen noise and protect the batteries. We are excited to be finding ways to add value in these growth markets. Finally, we are continuing to see increased testing by utility fleets for our ANG technology. Beyond trucks, testing of our large on-site storage tank is largely complete and we are operational with our methane capture and storage strategic partner GreenGasUSA. You may have recently seen GreenGas announce a 10-year offtake agreement with Enviva. This is their second, the first being with Duke University. Additionally, we published our 2020 sustainability report update last week that highlights Ingevity's ongoing commitment to operating sustainably, bringing high-performing, customer-focused solutions to the market and playing an important role in the global race to lower emissions. Our renewable raw materials and the significant environmental benefits of our technologies give us a competitive edge. I encourage you to read the update, which can be found on the homepage of our investor site. I want to thank the entire Ingevity team for their continued hard work in these challenging times. I continue to be impressed by the drive and determination of our entire team but particularly the operations and supply chain employees who work smart and safely day in and day out under these trying market conditions. I was able to visit our Engineered Polymer site in the UK this past quarter to thank them for what has been a remarkable story both supporting recovery in their existing markets and advancing new technology adoption. We are all excited about the opportunities they have in their future. With that I'll turn the call over to Mike to review the results for Performance Chemicals.

Thanks, John. On slide 5, we'll see our Performance Chemicals segment sales in the third quarter were $259 million, up almost 38% versus the prior-year period. Across all our businesses we realized growth through the adoption of the many sustainable and high-margin derivative solutions we offer customers. We're incredibly pleased to see demand for products across our Engineered Polymers portfolio continuing to grow. Quarterly sales in Engineered Polymers rose over 100% to an all-time record level due to the improved volume for all product lines across the globe and markedly higher demand in automotive and industrial equipment applications. In automotive, we realized strong technology adoption and sales growth in protective coatings and electric vehicle battery pads. In addition, our sales in bioplastic applications continue to show growth and we are encouraged by the increasing number of customers who are using these Capa solutions to meet their sustainability goals. In addition to volume growth, we also realized strong price improvement in Engineered Polymers which has been important to offset the inflation in raw material costs. Industrial Specialties sales rose 47%. Sales growth in adhesives, oilfield, and lubricants were all up over 60%. Adhesive sales growth was robust in both packaging adhesives and safety road strike. We saw the benefit of Q2 price increases come through in the third quarter and the business also implemented additional price increases for tall oil rosin and tall oil fatty acid products which are in effect for the fourth quarter. Chinese gum rosin prices continue to be higher than levels seen in the last five years, and supply-demand dynamics for rosin-based products and fatty acids remain strong. During the quarter we saw continued sales of soy-based fatty acid derivatives and straight soy-based fatty acid. These are important steps as we expand our product portfolio potential end-use applications by adopting raw material feedstocks beyond CTO. We also had our first commercial sales of TOFA into European biofuels and expect demand for this application to grow significantly going forward. Sales to Pavement Technology applications were up slightly compared to the previous year's quarter driven by continued adoption of our environmentally friendly whole recycling technology. Outside North America we realized strong sales growth in Europe, but that was offset by a reduction in sales in China which we attribute to temporarily reduced local government infrastructure spending leading to curtailed paving activities. Performance Chemicals segment EBITDA in the third quarter was $63 million, up 34% versus the prior-year quarter due to higher volumes and prices, partially offset by continued inflation in raw materials and logistics costs.

Thanks, Mike. As you can see on slide number 6, sales for the segment were down 18% at $118 million. Sales of our automotive activated carbon products were down compared to the third quarter of 2020 reduced by the shortage of microchips that continues to negatively impact global vehicle production. The microchip shortage is disrupting the automotive industry worldwide. In the quarter, North America light vehicle production declined 27% and has been sequentially declining quarter-over-quarter since the prior year's Q3. North America production remains at a favorable mix of 81% trucks and SUVs to 19% sedans. This truck and SUV mix has been in this range since the beginning of the year as OEMs are directing their limited microchip volumes to their most profitable vehicles, pickups, and SUVs. These vehicles are also beneficial for Ingevity as they typically have larger canisters and multiple honeycombs as part of their evaporative emissions control systems. US light vehicle inventories as of the end of September fell 64% to less than one million vehicles, compared to 2.7 million vehicles in inventory in September 2020. The decline is even greater when compared to the pre-COVID inventory of 3.6 million vehicles in inventory in September 2019. US and Canada vehicle sales were down 13% in the quarter, reflecting both the lack of vehicle production and the availability of vehicles for consumers to purchase. Additionally, China light vehicle production in the quarter was down 15% and sales were 14% lower versus the prior-year quarter. Based on IHS data, we estimate the Q3 impact to Ingevity of microchip-related production losses to be about $22 million to $28 million in revenue. We expect the microchip supply issue to continue through the rest of 2021 and into 2022. Lastly, US and Canada Tier 3 implementation is ongoing as some model year 2022 platforms were delayed by the pandemic. Remaining Tier 3 implementations should be completed by the end of the year or early in 2022. Segment EBITDA was $56 million, down 30% versus the prior-year period. Despite lower revenue, we maintained strong segment EBITDA margins at 48% in the quarter. In mid-September, we announced our intention to challenge an adverse jury verdict in the US District Court of Delaware. We don't anticipate an immediate impact on commercial sales and aren't aware of a competing certified or tested honeycomb that could replace sales of Ingevity's products immediately due to the multiyear automotive design cycles of OEMs and Tier 1 suppliers. This decision has no bearing on our '649 patent family obtained in the US, Europe, and China to reduce emissions and advance low purge engine technologies like start-stop, turbo, and sub-hybrid variations that we believe could apply to anywhere from 25% to 60% of future near-zero fuel system designs. Also in September, the US Patent Trial and Appeal Board recognized the validity of the patent in our newer '649 portfolio, following a post-grant review that was initiated by a competitor challenging certain claims within the patent related to the use of our standard and specialized honeycomb products. This win is a great outcome for Ingevity as we continue to add to the next generation of emissions control technologies in our Performance Materials IP portfolio. It recognizes our ongoing investment in research and development of automotive emissions control solutions using specialty honeycombs and canister design. As the world leader in the space, we're committed to continuing to leverage our expertise in complex, low purge engine innovations to help our OEM customers meet increasingly stringent emissions targets.

Thanks, Ed and good morning all. Please turn to slide 7. Here you see the healthy increase in revenues, which were up almost 14%. However, you also see the decline in both gross margin and adjusted EBITDA margin due to the reduced sales in Performance Materials and a significant mix shift in revenue versus Q3 of last year with Performance Chemicals revenue up 38% and Performance Materials revenue down 18%. In addition, our SG&A was up year-over-year, as we resumed more normal commercial operations including hiring to fill open positions, increased travel, and investment in growth and innovation resources. We remain focused on prudent cost management while ensuring we can meet the rebound in business activity. Interest expense for the quarter was $11.6 million, up a bit from last year, as we replaced our floating rate revolver borrowing in the fourth quarter of 2020 with a fixed rate bond with an eight-year maturity. Our tax provision on adjusted earnings was $16 million for the quarter, a decrease year-over-year reflecting lower earnings and also our earnings mix across different geographic locations. Our adjusted tax rate in Q3 was 19.8% and we estimate our full-year 2021 adjusted tax rate will be in the range of 22% to 24%. Diluted adjusted earnings per share of $1.62 are down from $1.79 in Q3 last year, reflecting the lower margins. Turning to slide 8. You'll see we generated solid free cash flow of approximately $75 million in the quarter as we remain focused on disciplined working capital management. We did see inventories in Performance Materials pick up somewhat in Q3 as the forecast for auto production deteriorated throughout the quarter and we're managing plant operations to optimize production and inventory as we navigate this dynamic environment. As we've previously stated, we will continue to be opportunistic with share repurchases. In Q3, we repurchased about $32 million of shares and year-to-date repurchases totaled about $100 million or 1.3 million shares. This leaves approximately $312 million available on our share repurchase authorization. Our leverage ratio, net debt to adjusted EBITDA was 2.1 times at the end of Q3, flat sequentially, and down from 2.7 times at the end of Q3 2020. Our average cost of debt was approximately 3.6% and we have no meaningful debt maturities until August of 2023. In summary, our balance sheet is strong. We're balanced and disciplined in our capital allocation as we have ample liquidity to support our inorganic and organic growth initiatives.

Thank you, Mary. On slide 9, I'd like to review our updated guidance for 2021. Our guidance for the remainder of the year reflects tempered expectations for Performance Materials and confidence in the continued strong demand for products in our Performance Chemicals portfolio in the fourth quarter. Our updated guidance for the full year 2021, the sales to be between $1.32 and $1.36 billion and adjusted EBITDA to be between $405 and $420 million. Throughout the rest of the year, we expect the ongoing shortage of microchips and continued logistics raw materials and energy inflation to be headwinds. We're also watching for any other issues that could also impact automotive production. We continue to monitor supply and demand in the market and will pass through costs to ensure we extract the optimal value for our products. Despite these challenges, our team is operating very effectively and we continue to execute on our strategy. We are being aggressive in the market, both in realizing value for our products but also in finding new applications. We are determined to take advantage of opportunities in this dynamic situation to maximize value today and in the future and our results reflect this. In closing, I appreciate the ongoing hard work and efforts of our employees worldwide and we thank them. We hope you share our enthusiasm for Ingevity. At this point, operator, we'll open up the call to questions.

Thank you. At this time, we will be conducting a question-and-answer session. Our first question comes from the line of John McNulty with BMO Capital. Please proceed with your question.

Hey. Good morning. This is Caleb on for John. I just had a quick question on the pricing dynamics you're seeing in PC in Q4 and maybe a little bit further out into 2022, especially with what you're seeing in Chinese gum? Thank you.

Yes. Thanks. At this point, we are really optimistic that our ongoing price increases will continue to be successful. The market is supporting it. As you mentioned, we've got a supply-demand situation on Chinese gum that remains quite favorable. It's about as good as it's been in the last five years. And so we fully believe we're going to continue to get additional price increases in the fourth quarter, and we're certainly optimistic as we enter next year that we'll have further opportunities.

Okay. Thank you. And then I was just wondering if you could provide an update on some of the longer-term initiatives you're working around, regarding methane capture and transportation and renewables and the like?

Well, we talked a little bit at the front of the conversation. I mean we're pretty excited about work across all of our what I would call 2.0 initiatives, right? We did announce GreenGas did announce two offtake agreements, but the big one that happened recently is within Enviva. They are a company that makes wood pellets that are used as a substitute for oil. Most of these pellets are sold in Europe. They generate methane. We'll be off taking that. The good news also is that our technology the tank that we've been using has now been cycled through sufficient times, where we rate that as being fully commercially viable. So we are out in the marketplace talking to a lot of different customers and a lot of different parts of sort of a methane value chain and we're going to continue to grow that. And then with regards to the fatty acids we talked a little bit about that as well. Our focus is on getting the soy processes in place next year so we can start ramping sales, but we're also looking at other feedstocks while we're focused on soy in the near term. Hopefully, that answers your question.

Yes, thank you.

Your next question is coming from the line of Jon Tanwanteng with CJS Securities. Please proceed with your question.

Hi. Good morning, everybody. Thank you for taking my question. I was wondering just on the Engineered Polymers business how much room do you have to grow there, given the demand and kind of before you have your capacity come online later next year?

We have ample capacity to meet any anticipated demand. As you may have seen, we recently announced expansion of 20% at our Warrington site for monomer production. We'll have more polyol production coming on in DeRidder next year, that will represent about a 35% increase in capacity for polyols. And so we're super pleased with the growth of that business and the outlook for future growth, and we're committed to ensure that we've got all the capacity we need to support it.

Okay. Great. And then just on the automotive business, I was just wondering in your discussions with customers. Do you see any relief coming anytime soon? Are they expecting it especially as we go through Q1 and Q2 of next year? Do you expect any kind of sequential increase in production as we had in Q4?

Yes. You've probably seen – this is Ed. You've probably seen and heard some of the announcements coming out of GM, Volkswagen and Ford. Effectively, their view is that this will continue throughout 2022. Our view is that we're expecting the first half to be roughly equal to our Q3 and Q4 with improvements occurring in the back half. Ultimately, when those improvements occur, it will be meaningful but the market at this point is so opaque it's hard to really understand when those additional chips will come out of supply.

Okay. Got it. And if I could do one more. Just on the ANG off-take agreement with your partner that you mentioned. I was just wondering how big that was in terms of how much carbon you could sell to support those volumes?

Well, for this particular situation, it's not good. I wouldn't characterize it as material, right? I think what I – the way we view it is a verification or validation that the business model or methane capture is a good one and a profitable one. And it will validate the technology that can then be used in a lot of different applications by a lot of different potential customers. So it's not going to be a big revenue push but it's a start.

Okay. Fair enough. Thank you, guys.

The next question is from the line of Daniel Rizzo with Jefferies. Please proceed with your question.

Hi, guys. Thanks for taking my questions. So given the obvious auto production slowdown and its effect on Performance Materials. I was just wondering why you noted in Performance Chemicals that auto production is kind of helping drive growth at least in Engineered Polymers. I was wondering why there's kind of a difference so I figured that would be under pressure as well.

Thanks, Dan. I think we've really got two very different situations. Within Performance Chemicals, it's really all about new technology adoption. And so when you think about the new business we have that's really getting some great penetration in protective films, it's coming from a very low base. As customers are aggressively adopting that technology we've got strong growth there. And then on the other side, we've got additional business in electric vehicles. And so the business for the microcellular polyurethane type applications for electric vehicle battery pads is new. EV sales continue to grow, and we're really pleased that a number of customers are choosing to use Capa technology in those growth areas within auto.

Okay. You mentioned that SUV sales are currently at 81% for SUVs and 19% for sedans, and part of this is due to the chip shortage, which has pushed automakers to focus more on trucks because they are more profitable. When the chip shortage improves, do you anticipate a shift back towards greater sedan production to catch up? How might this impact your business?

Yes, Dan, this is Ed. I don't think it's going to have an impact when that recovers. We supply canisters for SUVs, trucks, and sedans and all of them based on the size of their fuel tanks should be relatively similar especially for North America should be relatively similar content, obviously a little bit more content on the light-duty trucks with extra honeycombs on top of those. But from our overall view is that the profitable mix the OEMs are going to try to hang on to it as long as they can.

Thank you very much.

Our next question comes from the line of Vincent Anderson with Stifel. Please proceed with your question.

Yes. Thank you. So when I'm looking at the planned capacity investments in biodegradable plastics like PLA for instance obviously there's some good growth planned in the western world where you are now, but China's projections are starting to get like pretty aggressive. So I'm just wondering are you comfortable with your geographic footprint relative to that kind of regional disparity in growth, or do you feel like maybe there's an opportunity over the next couple of years to take what you learned from your US investment here and pursue something similar in Asia?

Yes. Thanks. And so yes, we are comfortable with our footprint and we're going to make sure that we can support the customers around the world. Now that said, as you can already see we're continually evaluating where the best new use of capital expenditure and capacity expansion should be. We're making our first move by making the polyol production here in North America. And I expect that we'll continue to diversify our capacity over time. But with working closely with our customers out of Warrington we've been able to supply growth in Asia as well as North America and we'll continue to balance and make the right investments in the right geographies to support the growth of the business.

Yes. I mean to be clear Vincent, we expect to participate in that market and we will make sure that we are resourced accordingly to support that.

Excellent. Thank you. And then this one is maybe a little left-field but when we think of batteries we're usually thinking about graphite, but with some of these alternative chemistries that are coming out here they're using what's called hard carbon, but to me, it seems very similar to your activated product. I'm just curious if you've done any work internally exploring opportunities there or even had any conversations with potential new suppliers in that space.

Yes, Vincent, this is Ed. We are actively exploring opportunities related to anything associated with carbon. We have looked into hard carbons.

We are looking at hard carbon.

Okay. Excellent. If I could sneak one more in. Just really quick. When I think about the soy oil investment, I'm just curious, are you producing enough here at this kind of proof-of-concept level to also start getting comfortable building commercial relationships for those products, or is that not really going to start in earnest until you're fully up and running?

We've begun to initiate the commercial arrangements. We've supplied initial commercial quantities to a number of customers from the product that we made here at our Charleston facility. And so, that work has begun. And so, we want to make sure that when the Crossett facility has a capability to ramp up in the second quarter next year that we're ready to step up sales and production in both supporting derivatives and for the soy-based fatty acid. And over time, that will continue to grow, but we're not holding back in starting those initial commercial engagements to set ourselves up for next year and beyond.

All right. Thanks. That’s all for me.

Your next question comes from the line of Ian Zaffino with Oppenheimer. Please proceed with your questions.

Hi. Can you discuss the auto space in general? Is there inventory of your product available? Has that been addressed? As the business begins to recover, how long do you expect it will take to see an increase in activity? Also, for the fourth quarter, what should we anticipate regarding sales in the auto sector compared to the third quarter? Thanks.

Thank you, Ian. I'll start with the fourth quarter. According to IHS data, the chip losses in the third quarter were approximately 3.5 million vehicles. For the fourth quarter, IHS currently projects losses of 1.6 million vehicles, but their range suggests it could be anywhere from 2 million to about 4 million losses. We believe that we will easily exceed 2.5 million losses, especially since we are one month into a three-month period. However, I anticipate that we will end up somewhere between 2.5 million and 4 million. As we mentioned earlier, we expect improvements in the first half of 2022, and we are actively monitoring the conversations with OEMs to understand this market better. We are relying on IHS for metrics while also engaging with OEMs and our customers to gauge when they expect demand to begin increasing.

If I could add to that, generally, Q4 is similar to Q3, but we are experiencing some outages, including our usual outages in Q4. We have our outages, OEMs have their holiday outages, and there are discussions about whether those might be extended, which gives us some caution. Is that accurate?

Yes. Okay. As for sales on the materials side, it seems your sales declined less than the industry average. I'm curious if there's some inventory in the channel.

We have continued to operate our facilities and have increased inventory slightly. All suppliers in the automotive industry have built inventories to respond to potential surges in chip supplies. Ultimately, we will manage our plans to optimize inventory going forward and ensure that our inventories are in balance with the demands of automobile companies.

Some of this is about the mix. As their absolute volumes decrease, they are shifting their mix and continue to produce SUVs and trucks, which use more of our carbon and honeycombs. This explains a lot of the difference between our sales and those of the OEMs.

And we also expect OEMs to build their inventories once the chip shortage alleviates or as Ed mentioned too.

Perfect. Thank you so much.

Our next question comes from the line of Paretosh Misra with Berenberg. Please proceed with your question.

Thank you. Good morning. Could you talk about the patent that is expiring next year? As you get close to the March deadline, are you seeing competitors bringing on new capacity? Could that be a risk for next year, I guess is what I'm trying to get to or not so much?

Yes, Paretosh, this is Ed. We don't look at it as a risk. We've been anticipating the '844 patent to expire in March for 20 years, but also well prepared for it. At this point, we do not see a competitive product certified or tested honeycomb that could replace the sales of our honeycombs immediately. And again, primarily due to the multiyear design cycle but also the fact that it takes a lot of work and effort to get a product certified. So again, at this point, we just don't see any competitive product out there that would be impacting our revenue going forward.

Thanks, Ed. And then, one of your competitors in pine chemicals was recently acquired. So just curious if you're anticipating any changes in the landscape because of that or is that largely a neutral event for you?

I mean, look Paretosh, I mean we have to approach it as a neutral event. But obviously, we're always looking for opportunities in the marketplace and to the extent there's any disruptions that might occur as a result of that transaction we intend to be there to take advantage of it.

Got it. And maybe a last one. I think you mentioned some electric vehicle products from your Performance Chemicals segment. Do these products have an aftermarket as well or is it primarily in OEM business?

It's an OEM business. Yes.

When we discuss the protective films that some people in the US consider using to wrap their cars for protection, this can be seen as an aftermarket application.

For both EVs and for internal.

Many customers are deciding to wrap their cars right before selling them, while others are opting to apply the protective coating after they have made their purchase.

I mean Paretosh, look, we called it out because it's an example of new applications. I think the Performance Chemicals segment more broadly has done a great job of being very aggressive at trying to find new markets and new applications. And obviously, EV set aside its relationship with Performance Materials, these are attractive high-growth markets and we've got multiple entry points across that segment. Inspec is working on lithium mining, Capa's working on applications for the automobiles and we're going to keep looking for areas where we can participate in that market.

Got it. Thanks guys. Good luck with everything.

Thank you.

Thank you.

Our next question comes from the line of Michael Sison with Wells Fargo. Please proceed with your question.

Hi. This is Richard on for Mike. First question, you did a great job in terms of pushing price increases to more than offset raw material cost inflation. Can you just maybe give some color in terms of where you're seeing the impacts on a raw material side as well as on the availability and logistics and how we should think about that? Has it gotten worse heading into the fourth quarter stabilized?

I think we've not seen it. I mean it's a tough one to answer. I mean each segment has its own set of issues, right? But the reality is that we're seeing raw material and we're just seeing headwinds across the board, right? I mean transportation costs everyone is aware you can turn on the news at night and see all the ships backed up. But we're paying more, right? And our raw materials across the board are really getting inflated. So we're working hard to offset that. We're no different than any other company out there and we'll keep doing what we need to do.

Okay, great. And then on Performance Chemicals, maybe if you could talk a little bit about within Industrial Specialties, oilfield technologies, I think last quarter you mentioned it was up 40% year-over-year. Are you still seeing continued growth there? And what's your outlook for that for the rest of the year in 2022?

Yeah. In fact we saw really strong growth in the third quarter. Now it's important to remind ourselves that the third quarter of last year was quite low for oilfield, but that was an application within Industrial Specialties where sales growth was up above 50%. As we look forward and we look at the outlooks that get projected by industry experts, the outlook for drilling activity here in North America in the next number of year’s looks to be growing in quite a solid manner. So we are going to ensure that we support that business as well as the ongoing work we've got. We've had to expand our geographic footprint beyond North America especially in Middle East and China, two markets that represent good opportunities for us to utilize our oilfield technology.

Great. And then just finally on Pavement Technologies that is relatively flat versus prior year. Maybe you could talk about how we should think about the growth for that business through the next 12 months?

Our Pavement Technology business has consistently shown solid mid to slightly higher top-line growth over time. This year, and even in this quarter, if it weren't for the downturn in China, we would be discussing growth rates that are similar to those we’ve seen before. I believe there is significant opportunity to further adopt our technology in Pavement. We have increasing chances to fully globalize that business, and we are keenly observing infrastructure and highway bill spending, hoping for substantial investment in that area. While we are not relying on that to create any near-term major changes, it can only serve as a positive influencer for the business. Overall, I think the potential for continued growth in this area is quite strong.

Great. Thank you.

Thank you. Our next question comes from the line of Chris Kapsch with Loop Capital Markets. Please proceed with your question.

Good morning. I have a question regarding the TOFA sales in the European biodiesel market. Are these sales replacing other TOFA volumes, or are they additional? If they are additional, could you provide some insight into how significant these volumes are? Are they sufficient for you to operate your domestic refineries at higher rates, which would allow you to produce more tour, especially considering the current shortages due to the situation in China? Would this also have a positive impact on unit costs? I'm looking for some clarification on this.

I'll start, but Mike can elaborate. The current situation allows us to operate our refineries at very high rates, regardless of the biofuel market conditions. I believe that as that market develops and becomes more profitable compared to other options, it will expand. However, I don't think we need that production to operate our plants at higher utilization levels right now.

John is correct. We need to balance the biofuel in our total production. It's very encouraging to see a new significant source of demand for TOFA. Over time, this should positively impact the supply-demand dynamics and pricing for TOFA. Our goal is to enhance the profitability of the business, and if the European biofuel pricing presents the best opportunities for Ingevity, we will allocate TOFA there. If other markets offer better potential, we will pursue those as well. We ensured that our logistics and customer relationships were well prepared to supply that market, which we accomplished. In the third quarter, we made our first sales of TOFA to a large significant customer, and we will monitor how that develops moving forward.

That's helpful. And just as a follow-up if I'm interpreting your response right, sounds like just the fundamentals in Chinese gum rosin have allowed you to increase rates to get more TOFA product. Just curious if there's any governors on your utilization rates in the refineries, such as the availability of CTO, or should we expect kind of at least near-term an upward bias in those utilization rates with the strength in overall demand? Thanks.

I believe we have a positive outlook for growth in the future. However, as we've mentioned, the availability of CTO may become limited, and we are focused on ensuring that any CTO we purchase from the market can be converted into profitable business. We have acquired sufficient CTO to meet our plans for the upcoming year, so we are in a solid position. With strong input and demand for our output, we will continue to run the business and enhance its profitability.

Yes. I mean, just to be clear, Chris, we have our CTO secured for next year, so we are not going to be CTO constrained. Part of the long-term strategy around TOFA is that by running these processes in parallel, we will actually get incremental yield. And if we can substitute TOFA in some of our products, we will actually have more TOFA to sell in the marketplace. What we're trying to do is actually enhance the yield overall the network so the bias would be upward in your Lexicon relative to what we know is secured CTO.

Appreciate the color. Thanks.

Our next question comes from the line of Jon Tanwanteng with CJS Securities. Please proceed with your question.

Hi. I was wondering if you could just talk about your ongoing legal expenses and kind of what your outlook is for that? Just in terms of strategy and litigation costs going forward?

Yes, Jon, this is Ed. We're likely to return to a more normalized level. So think of it about as a third of what we had been spending.

Okay. My impression was that was roughly $5 million-ish a quarter, isn't that about right?

Yes. So $15 million on an annual basis, so $5 million going forward.

That's per year, Jon.

Got it. Okay. Thank you so much.

Thank you for your time this morning. We remain incredibly positive about our long-term business outlook and look forward to talking with you again next quarter.

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