Ladies and gentlemen, thank you for standing by. And welcome to the Ingevity Fourth Quarter and Full Year Earnings Conference Call. Over the conference, all the participant lines are in a listen-only mode. There will be an opportunity for your questions and instructions will be given at that time.

We do ask if you please limit yourself to one question and one follow-up. As a reminder, today’s call is being recorded. I'll turn the conference now to Mr. Dan Gallagher, Vice President of Investor Relations. Please go ahead sir..

Thank you, John. Good morning, everyone. Welcome to Ingevity's Fourth Quarter 2018 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’d encourage you to download this file so you can follow along on the call.

You can find it by visiting ir.ingevity.com under Events and Presentations. 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 these projections and forward-looking statements made during the 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 number 3. With me today are Michael Wilson, President and CEO; and John Fortson, Executive Vice President and CFO.

First, Michael will comment on the highlights of the full year and fourth quarter, review the performance of our two segments and provide an update on our strategic initiatives. John, will discuss our current financial status, our outlook for 2019, and our initial guidance for the year.

Then Michael will make some brief closing remarks before we open the line for Q&A. Mike Smith, President of Performance Chemicals; and Ed Woodcock, President of Performance Materials will join for the Q&A. And with that, I'll turn it over to Michael..

Thanks, Dan. Good morning, everyone. Thank you for joining us this morning and for your continued interest in Ingevity. If you'll turn with me to slide number 4, I'd like to start this morning's call by reviewing how we've delivered versus the commitments we made at the beginning of 2018 and from the time of our spin-off in 2016.

In 2018, we exceeded our original guidance in terms of revenues and adjusted EBITDA by 3% and 9% from the midpoint, respectively. We executed our capital program as planned, though we accelerated spending slightly when we released the strength of our performance in the year.

Still our free cash flow was 67% higher than originally projected and as a result our net debt-to-EBITDA ratio came in under our forecasted range. Lastly, our segments are ahead of the schedule towards meeting the revenue growth and adjusted EBITDA margin goals we set for them back in 2016 at the time of the spin.

Our market valuation has continue to reflect the growing understanding and appreciation of our performance and our potential. As a result our shareholders were rewarded with a total return of 19% for the year. We're very proud of our team's performance last year, but all of that is now in the rearview mirror.

As you know we aspire to sell much more and we are looking ahead to achieving our next set of milestones. Our objective is to continue to be a leading specialty chemicals and materials company with an atypical growth trajectory, premium margins, a strong balance sheet and excellent returns.

In our short three-year tenure as a public company, we've provided strong evidence of our ability to be just that. Our performance of the fourth quarter was no exception. If you'll turn to slide number 5, you'll note some highlights for the quarter.

As you can see, we delivered another outstanding quarter, one that frankly exceeded our expectation and capped off a very strong year for Ingevity, and what is essentially a slower quarter, we realized higher volumes and improved price and mix.

Revenues in the fourth quarter were about $279 million, which is up more than 21% when compared to the previous year's quarter. Adjusted EBITDA was $73 million, up more than 39% versus the prior year's quarter, predominantly due to the revenue impacts with some benefit from lower raw material costs.

These positives were partially offset by higher freight and distribution costs, increased spending related to a plant planned outage and higher legal expenses. Our fourth year adjusted EBITDA margin of 26.3% was up 340 basis points from the prior year.

Also on Slide number 5, you'll find the results for the full year on revenues that increased about 17%, including the acquisition of Georgia-Pacific's pine chemicals business; we drove an adjusted EBITDA increase of more than 32%.

This resulted in an adjusted EBITDA margin of 28.3% of sales, representing an increase of 330 basis points versus the prior year. Moving to the segments. You can see on Slide number 6, Performance Chemicals posted another strong quarter.

Segment sales in the fourth quarter were $166 million, up about 20% versus the prior year period, due largely to the G-P acquisition, which contributed significantly to our oilfield technologies and industrial specialty sales, but did not affect our pavement technologies business.

Sales of Performance Chemicals products to oilfield customers were up approximately 53%. More importantly, on a pro forma basis, which assumes we had owned the G-P business for the entire year of 2017, sales were still up 17%. This occurred on the strength of U.S.

drilling despite some softening later in the quarter, as customers reacted to oil price uncertainty in the market. According to Baker Hughes, U.S. rig count at the end of the fourth quarter was up 2.7% versus the third quarter. However, it seems rig count is vacillating as it's already down 3.6% at the end of January from the beginning of the year.

Sales to pavement applications increased by about 2% in the seasonally much slower fourth quarter for the U.S. market. Sales were augmented by continued penetration in international markets such as, Peru and China, as we continue to globalize this business.

Sales into industrial specialties applications and these include printing inks, adhesives, agricultural chemicals, lubricants and others were up about 18% versus the prior year period. Again, the increase was largely driven by our G-P acquisition.

However, we achieved strong growth in adhesives, as we gained share versus hydrocarbon resins and road safety striping. And we continue to drive sales in niche applications, such as, agricultural and lubricants.

In addition, sales in industrial specialties benefited from higher selling prices for tall oil fatty acids, or TOFA, which rose in the low double-digit percentages. These successes enabled us to partially replace the lower margin printing inks business.

The net impact of the shifts across oil field, pavement and industrial specialties was a substantial improvement in segment profitability and margins. Performance Chemicals segment EBITDA of over $30 million was up 100%.

In addition to the revenue impacts, the increase was a result of lower costs per crude tall oil or CTO and synergies gained through our G-P acquisition, these were partially offset by higher freight and SG&A costs. Overall, we drove an improvement in EBITDA margins of 730 basis points to 18.3%.

On a pro forma basis, while revenues were essentially flat, segment EBITDA was up 32%. For the full year in Performance Chemicals, sales were $733 million, up almost 18% versus 2017. Segment EBITDA of $151 million, was up almost 50% versus the prior year.

Our EBITDA results benefited from our ability to increase and accelerate synergy capture from the G-P acquisition. These synergies contributed $3 million to $4 million in each of the last three quarters, surpassing the year three $11 million annual target we communicated when the deal was announced.

Performance Chemicals adjusted EBITDA margin for the year was 20.6% that's up 440 basis points from a year ago. For the full year, revenues on a pro forma basis increased 4% yet because of the success, the team has had in recovering price, capturing cost reductions, and moving to higher-margin applications, segment EBITDA was up 22%.

Turning to slide number 7. We were pleased to announce yesterday that, we have completed the acquisition of the Capa caprolactone business from Perstorp Holding AB. I'd like to take this opportunity to remind you why we're so excited about this acquisition.

First and foremost, Capa is a complementary market-leading business focused on high-growth end uses. It is the clear global leader in caprolactone and caprolactone derivatives, with unique technology and a state-of-the-art facility. Capa's capacity is three times that of its closest competitor of, which there are only two others globally.

In addition Capa aligns with our business model and capabilities mirroring the way we go to market and how we add value for our customers.

Both Capa and Ingevity focus on leveraging close customer relationships and strong end-use technical expertise to create businesses where our customers recognize us as technological innovators, thought leaders and partners in their businesses.

Both Capa and Ingevity operate similar manufacturing processes as we both prefer to derivatized our basic products into higher value downstream products that bring unique performance and functionality characteristics to our customers products.

Capa will also provide new avenues for strategic growth and value creation both organically and inorganically. And we intend you to continue to invest behind this business. And finally, Capa has a top-tier financial profile. The business has delivered strong historical revenue growth posting an average 10% CAGR over the past five years.

More importantly, Capa has consistently achieved adjusted EBITDA margins in the mid-30% range. Its maintenance capital requirements are generally modest and its cash conversion rate is historically high. In 2018, sales for Capa were approximately $175 million and adjusted EBITDA was about $60 million.

We attribute about $1.5 million of adjusted EBITDA to increase volume resulting from a competitor's unanticipated outage in 2017 that carried over marginally into 2018. While Capa will be accretive to margins and earnings this year we are most excited about what this business will do for Ingevity over the long term.

The Capa financials will be reflected in our 2019 guidance, which we'll discuss later in the call. Going forward, this business will be part of our Performance Chemicals segment and will be titled as our Engineered Polymers application. Moving now to Performance Materials.

As you can see on slide number 8 the segment once again delivered outstanding performance. In fact this was a record quarter for both revenues and adjusted EBITDA for the business. Segment sales in the fourth quarter were $113 million, up about 24% versus the prior year's quarter.

Volumes continue to be driven by strong sales of our honeycomb scrubber product used to meet U.S. Environmental Protection Agency Tier 3 and California LEV III standards.

In addition, we experienced robust pellet sales in the quarter, which is a clear indicator that we're beginning to see the benefits of early regulatory adoption in China and to a certain degree in Europe. According to Wards, light vehicle production was up about 2.2% in North America.

However, quarterly light vehicle production in China was down nearly 16%. The fact that our Performance Materials segment was up so significantly, despite the weak auto demand in China, speaks to the regulatory-driven nature of this business. Performance Materials adjusted EBITDA of $43 million, was up almost 15% versus the prior year's quarter.

This translated to a 38.1% adjusted EBITDA margin, which is down 300 basis points from a year ago. Profitability was driven by the favorable revenue impacts, but was partially offset by a major plant outage, the placement of an activation kiln at our Covington facility and higher freight costs.

In addition, legal expenses necessary to defend our intellectual property were meaningfully higher. For the full year of 2018, Performance Materials segment sales were almost 18% higher versus the prior year. Segment EBITDA was about 20% higher, resulting in an increase in the segment EBITDA margins of 170 basis points to 42.3% for the year.

As I mentioned, our Performance Materials business is benefiting significantly from advancements in regulations related to gasoline vapor emission control around the world. On slide number 9, we have summarized the regulatory changes that are underway globally. We are seeing continued strong demand for our technologies designed to meet U.S.

EPA and California Tier 3 LEV III regulations. The regulatory implementation schedule for the U.S. and Canada steps up in the second half of this year to 80% compliance for 2020 model year vehicles. We estimate the current compliance to be near 70%.

In Brazil, a resolution announced in December by that country's National Environmental Council mandates that in 2022 automakers must implement a two-day parking standard. In addition, implementation of U.S. Tier 2 type systems will begin in 2023 and are to be completed by 2025.

For your reference, Brazil auto production in 2018 was approximately 3 million vehicles. In Europe, the EU is continuing to implement its Euro 6d two-day parking standard on all new gasoline vehicles by September of this year. What's more, there's a continued shift in the EU away from diesel.

According to the most recent data in 2018, diesel-powered vehicles lost an additional 8% market share to 36%. The majority of which moved to gasoline and hybrid vehicles, which require evaporative emission canisters. And China, as previously discussed, is implementing its national China 6 regulation, which will require U.S.

Tier 2 type systems on all new gasoline light vehicles in the country by mid-2020. Each quarter, we have provided updates to our understanding of the latest information regarding early-adopting regions and cities in China. If you'll turn to slide number 10, you'll note our updated map.

Since our last call we have learned that the Hainan and Henan provinces and Shenzhen city have announced that they would push out their implementation time lines by six months shifting from January 1, 2019, to July 1. Also Guangzhou city moved its implementation by two months from January 1 to March 1.

So while our estimate of early adoption six month ago for the first half of 2019 was about 19% that's now moved to about 3%. Yet the percentage of announced early adoption by July 1, 2019 is still expected to be more than 60%.

These shifts and announced adoption aside, we take our recent increase in pellet sales as an indicator that early adoption is beginning and that automakers are implementing ahead of the regulatory compliance dates. We are well prepared to meet the needs of our customers in China.

Moreover, we're confident our technological leadership and the investments we've made in manufacturing capacity globally will serve us well as various regions and countries continue to shift to more stringent regulatory standards.

Before I turn the call over to John, I'd like now to take a minute to provide some color around progress towards our strategic initiatives. If you move to slide number 11, you'll note on the left the six elements of our strategy that we rolled out at our Investor Day just a year ago.

To start, we said consistently that we gain value for our sales only when we create value for our customers and we continue to do just that.

In fact if you go to our website under News and the Ingevity Effect Blog, you'll find a series of customer success stories in both print and video, outlining various ways in which we've helped our customers at Anchor USA, Halifax Paving, Protomatic and the Orange Water and Sewer Authority to name just a few.

As the need for our products is either mandated or preferred in emerging markets, we are expanding geographically in both sales and manufacturing.

For example in 2018 we continue to drive adoption of our innovative Evotherm warm-mix asphalt product and our pavement technologies business is now doing business in eight new countries versus the prior year and over 13 in the past two years.

In Performance Materials, we constructed and launched a new start-of-the-art activated carbon extrusion plant in Changshu, China. Long an Ingevity hallmark innovation continues to be a critical pathway for growth.

Last year we built on our broad technology platform launched 20 new products and filed five new patent applications in Performance Chemicals. We filed additional new low-purge patent applications in Performance Materials. And we made progress in developing and promoting our adsorbed natural gas, ANG technology for bi-fuel vehicles.

At Ingevity we aim to operate our businesses superbly and always with an eye to continuous improvement.

Capital plan execution was on point in 2018 and included several significant projects such as the continued ramp-up of our Zhuhai, China facility; construction of the Changshu plant, kiln replacement and capacity expansion at the Covington, Virginia side; continued expansion at the Waynesboro Georgia honeycombs scrubber facility and integration of the Crossett Arkansas product slate into our Performance Chemicals offering.

Our growth is being accelerated through strategic value-creating acquisitions. In 2018 we completed the G-P Pine Chemicals acquisition, acquired the remaining interest in Purification Cellutions and announced our intent to acquire the Capa caprolactone division of Perstorp.

In addition to the significant capital we've invested into our existing businesses, we've invested approximately $1 billion of capital into new businesses in order to continue providing superior returns to our shareholders. And finally as a result of our efforts for the full year adjusted EBITDA of $321 million were up 32% versus 2017.

Ingevity's 2018 adjusted EBITDA margin of 28.3% was up 330 basis points. Free cash flow was $158 million up $36 million or 30%. And return on invested capital was over 23% which is in the top quartile of our peer group of Specialty Chemicals producers.

All in all, we are well on our way to realizing the target 2022 objectives we set at our Investor Day early last year. At this point, I'll turn the call over to John Fortson, our Executive Vice President, CFO and Treasurer for a more detailed review of our financial status and our guidance for 2019.

John?.

Thank you, Michael. Good morning everyone. There are three areas I will speak to. First I will provide some additional details on our financial performance in the quarter and over the year. Then I will review our cash generation and capital structure. And lastly, I'll review our outlook and 2019 guidance.

On slide 12 you'll find some key income statement metrics. The fourth quarter and the year were very strong for Ingevity. As Michael has covered revenue and EBITDA I will start with some additional color on SG&A. Fourth quarter 2018 SG&A of $36 million was up $8 million from the prior year quarter.

As a percentage of sales, fourth quarter 2018 SG&A was 12.9% compared to 12.2% from the prior year quarter. Impact in the quarter-over-quarter comparison was 2018 amortization of $3.2 million associated with the amortizable intangibles acquired as part of the G-P acquisition.

Adjusting for this SG&A as a percentage of sales for the 2018 fourth quarter was 11.7%. For the full-year, the G-P amortization was $10.6 million. And adjusting for this amount full year SG&A as a percent of sales in 2018 was 10.7% compared to 10.9% in 2017. For the fourth quarter of 2018, we recorded net interest expense of $8 million.

For the full year, we incurred $30 million. These numbers are up from 2017 and reflect the issuance of our $300 million 4.5% high-yield bond as well as increases in the LIBOR rate over the course of the year. Our provision for income taxes on adjusted earnings this quarter was $5 million and $45 million for the year.

This resulted in an adjusted non-GAAP tax rate of 10% for the quarter and 19% for the year. The tax rate during the quarter was favorably impacted by U.S. tax reform due to further guidance on the application of the new tax law. We reported GAAP net income attributable in the quarter of $42 million and non-GAAP adjusted earnings of $45 million.

Diluted adjusted earnings per share were $1.07. For the full year, GAAP net income attributable was $169 million, representing an increase of 34% and non-GAAP adjusted earnings were $176 million, representing an increase of 60%. Diluted adjusted earnings per share were $4.13, representing an increase of over 60% from 2017.

We had $41.9 million basic and $42.5 million diluted weighted average shares outstanding as of year-end. During the fourth quarter, we repurchased 350,000 shares of our stock at a weighted average cost per share of $83.81. Of these 284,000 shares were bought in December.

In total, we spent $29.3 million on share repurchases during the fourth quarter and we have $396 million remaining on our share repurchase authorizations. We remain committed to offsetting dilution and supporting our share price when we deem it necessary.

However, our priority in the near term remains deleveraging to our target leverage level to two time to 2.5 times net debt to EBITDA. On slide 13, you'll find some key balance sheet and cash flow information. As of December 31, our cash and cash equivalents were $78 million.

Total debt was $759 million including our capital lease obligation amount of $80 million related to our Wickliffe IDB. We finished the quarter with an original $71 million of restricted cash for the IDB. Net debt was $610 million which resulted in a net leverage ratio of 1.9 times.

As of December 31st, $748 million of our $750 million revolving credit facility was available to us. At year end we were borrowing at LIBOR plus 125 basis points in our revolver and term loan.

Trade working capital for the year increased versus 2017 to $217 million due to increased sales in the payables and receivables that go with them as well as the seasonality of our business. Underlying these numbers we continue to build inventory in Zhuhai to address the growth demand from China.

These increases in the Performance Materials segment have been partially offset by strong inventory and capital management in the Performance Chemicals segment. In fact, Performance Chemicals after adjusting for the G-P acquisition actually finished the year with working capital that was $10 million below last year.

Cash from operations for the year was $252 million. Our capital expenditures were $94 million over the same period. For the year, as Michael said, we generated $158 million of free cash flow, representing an increase of nearly 30% versus 2017. Additional information will be available on our 10-K which we expect to file on February 20th.

On the next slide, you'll find some guidance to help you think through the modeling the impacts of our Engineered Polymers application. We expect to file audited prior three-year and 2018 nine-month historical and pro forma financials for Capa sometime in early April.

Much like we did for the G-P acquisition, we were cautioned reading too much into these historical numbers or any others that are in the public domain as the nature of the financial relationship and pricing agreements between Capa and its parent Perstorp are very different from what we plan them to be under Ingevity's ownership.

In addition to changes in the depreciation and amortization, the intercompany transactions presented in the standalone Capa financial statements, for instance, debt interest expense as well as the removal of licensing and managing expenses among other adjustments will be eliminated at the Ingevity consolidated level.

Further, we are aware that the growth in Capa's historical revenue and probability was positively impacted by a competitor's outage. However, as Michael said, in 2018, the benefit to Capa from this outage was only $1.5 million.

As we discussed when we announced at the signing of Capa, the baseline 2018 full year numbers we are using for planning are $175 million of revenue and $60 million of EBITDA.

While preliminary and subject to change, for planning purposes, we are estimating the goodwill will be around $310 million and the amortizable intangibles will be approximately $220 million. The intangibles are expected to be amortized over a 12 to 14-year period.

The transaction should add an annual incremental $25 million to $30 million of depreciation and amortization to our current base D&A of approximately $60 million for 2019. As these numbers are still being finalized, I would encourage you to look at our pro forma filings that we expect to file with the SEC in April.

We have initially funded the acquisition by drawing down our revolver capacity. Due to our increased leverage we will borrowing initially a LIBOR plus 150 basis points. As we discussed at the time of the transaction's announcement, we may turn some of this debt out at a future date.

We are excited about the potential for growth in the coming years that Capa brings as we pursue continued market penetration of its products and innovative technologies. We welcome the Capa team to Ingevity. Turning to slide 15, you'll see our outlook and guidance for 2019. You should note that our guidance includes the Capa business.

In our Performance Chemicals overall, we are taking are very conservative view as we start the year. Across all the businesses in this segment, we are focusing on growing higher-margin applications, increasing price to offset inflation costs and continuing on our path to drive margin accretion.

We are forecasting very modest top line growth for Capa, as we begin the process of integrating the business into Ingevity. We are entering into a transition services agreement with Perstorp that will add some additional short-term cost. We will work to get off those arrangements as quickly as possible, but some may last for much of the year.

In addition, we will have three weeks of maintenance outages in the Monomer Plant at the Warrington, England facility over the course of the year. These planned improvements will increase the reliability and efficiency of our operations. However, the one-time cost should largely offset EBITDA growth generated from higher sales.

While the outlook regarding Brexit is uncertain, the capital organization has made plans to increase raw material inventory in the U.K. as well as finished goods in Continental Europe to minimize potential disruptions to serving our customers.

At oilfield, we expect volumes to be flat versus last year, assuming crude oil prices remain at current levels. We are in close communication with our customers regarding demand. Our customers are basing their projections on a WTI price in North America averaging around $55 a barrel for the year.

In pavement technologies, we expect to continue to deliver solid high single-digit growth consistent with our growth over the last several years. This will be driven by continued technology adoption in the globalization of our business. For sales to industrial specialties applications, we will continue to shift our business to higher-margin uses.

This is expected to result in lower volumes, specifically from exiting low-margin ink business in Europe and that result however, will be higher margins. And overall, we have assumed modest increases in freight cost and raw materials including CTO. By the end of 2018, our CTO cost reached what we feel is the market price.

We now anticipate modest inflation in CTO cost given the balance in the supply and demand. In Performance Materials, we expect to see revenue and probability benefits from the increased regulatory requirements, Michael described, in the U.S. China and Europe.

As we've indicated before, this business is currently driven predominantly by the adoption of these regulations, so any potential weakening in auto sales in the U.S., China and Europe will be offset to a degree by the positive regulatory impacts in these regions.

From a cost perspective, as we work through my pre-adopted inventory in China, we'll be cycling through higher-cost product manufactured during the ramp-up of the Zhuhai plan. Finally, we will continue to proactively defend our intellectual property, therefore, we anticipate higher legal expenses during 2019.

On the right of the slide, you'll see our guidance for the year of sales between $1.3 billion and $1.36 billion, and adjusted EBITDA between $390 million and $410 million. At the midpoint, we expect to increase revenues about 17% and earnings by almost 25% versus 2018.

While we do not provide quarterly guidance, I would like to describe how we see the cadence of the year playing out. As most of you who follow us know, the first and second half of the year tend to be fairly symmetrical.

However, in 2019 due to the mid Q1 closing of the Capa acquisition and the regulatory growth in the Performance Materials segment in the second half of the year, we expect the second half of the year's EBITDA to be mid to high single-digit millions of dollars higher than the first half. Our tax rate is forecasted to be between 21% and 23%.

CapEx is expected to be between $110 million and $120 million, with approximately $15 million to $20 million of that number dedicated to the Warrington site. Free cash flow should be between $180 million and $190 million. With the Capa acquisition, our net debt to EBITDA has risen to 3.5 times.

However, we anticipate finishing 2019 with our net-debt-to-EBITDA ratio at less than 3 times. As we look forward, we are focused on execution across the company as we prepare to capture the opportunities of 2019. We are prepared for the increases in both carbon and honeycomb demand in the U.S., China and Europe.

In the Performance Chemicals segment we are focused on growing our higher-margin applications. I will now turn the call back to Michael..

Thanks, John. Look, in summary, we had a great quarter and a great year and we're looking forward to 2019. I appreciate the work and efforts of our 1,700 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 up the call to questions..

[Operator Instructions] And just as a reminder, we ask if you please limit yourself to one question and one follow-up. You can place yourself back into the queue and we'll get to as many questions as time permits. All right. First we'll go to the line of Chris Kapsch with Loop Capital Markets. Please go ahead..

Yeah. Good morning. So I had a question about your M&A strategy, in the context of your ambitions for the company overall and your formal remarks.

So it looks like on a pro forma basis, roughly, your net debt will be a little over 3 times, but the free cash flow, if that's devoted to debt reduction, maybe you finish 2019 around 2.7, still above your targeted 2 to 2.5.

So in that context, in terms of additional M&A opportunities, where do you think you are in terms of timing on that? You want to digest Capa before you look to add additional opportunities? Or do you think you have the bandwidth that if something opportunistically crossed your plate you might be able to transact in the course of 2019?.

Chris, let me fix the -- you're thinking on the net debt to EBITDA and then I'll let Michael comment on the strategy. We closed the year at 1.9 times, right? We just closed Capa yesterday. When you do the pro forma to include the debt from what we used for Capa, which is about $650 million of incremental debt, you end up with 3.5 times.

So sitting here today, we're at about 3.5 times net-debt to EBITDA. Given our cash generation profile for 2019, we should finish the year at just around 3 or slightly below 3 time. All right? So that's how the year will play out, but I'll turn to Michael on the M&A..

Yes. Chris, that's a great question. I think as John just pointed out, I mean, given our outlook for 2019 and cash flow, we will still be above our sort of targeted 2 to 2.5 times net-debt-to-EBITDA leverage ratio.

But I don't really think that hinders us strategically in any way, if the right kind of opportunity comes along that we feel is value creating for shareholders. Our capital allocation priorities remain the same. It's first and foremost to fully invest in our existing businesses that now includes Capa. We want to fund those growth opportunities.

We do see ourselves as a growth company long term. We will continue to pursue value-creating M&A. And then third and lastly, assuming we can't find those opportunities or unsuccessful in doing, so we'll return cash to shareholders. All that said, clearly, right now in the short term, we do have a focus on de-levering in 2019.

And we'll do that, while we continue to screen the market for great opportunities..

Okay. And I just had a follow-up also on the pro forma modeling assumptions for Capa.

The baseline assumptions that you had for 2018, given that that Capa supplies the global Engineered Polymers industry while the Palmer-oriented companies obviously experienced a pretty dramatic downdraft in their demand associated with the somewhat vicious destocking cycle.

So I'm wondering if Capa experienced that in 2018 has that sort of influenced the pro forma number that you are using as a baseline for 2018? Thanks..

No. I don't think so. I don't think Capa really saw that. There's a lot of different polymer businesses out there. Some are very commodity oriented. This is a very specialty business. I mean, it – these are products that add very distinct functionality when added in small percentages to our customers' end products and end uses.

And we just do not see that across the board. Our conservatism regarding Capa in 2019 and we clearly covered this I think in our prepared remarks is that, we are expecting a significant outage in the second half of the year in Capa as we replace some glassware in one of the Monomer lines.

We anticipate we will initially have some higher cost associated with the TSAs that we will have with Perstorp until we can work our way out of those. However, our priority there is to do that as quickly as possible. We also recognize that, there is uncertainty associated with Brexit.

We are certain to have some higher costs associated with freight and distribution and warehousing as we pre-stage, raw materials in country and in products out of country to be prepared for any disruption that happens. And so those are basically the reasons for conservatism.

The outlook for the business, the business ability to continue to pursue derivative growth and penetrate new markets, we think is unfettered..

Thank you..

Our next question is from Ian Zaffino with Oppenheimer. Please go ahead..

Hi. Great. John, I know when you were talking about the ramp seeing second half better than the first half. You mentioned some of the compliance.

I was just more curious about have you been discussing with any of your customers the potential that they would actually go to 100% compliance on the auto side? Or is it really just going to be 80% and then we have to wait really until 2022 to see that 100%? What are they saying what are the feedback? What are you hearing there? Thanks..

Ian, this is actually Michael. And there is a regulatory schedule out there for the – the adoption for the U.S. and Canada which does have step ups. The next one being with 2020 model year vehicles which we'll see in the second half of 2019 to 80%, and then of course, 100% by 2022 model year vehicles.

But we sort of over the last quarter or two tried to convey that our view of what's happening has changed.

Rather than automakers waiting for these implementations dates to make a step change in the compliance rate they seem to be on more of a gradual ramp, simply moving to the new technology as they replace model years or as they update model year vehicles.

So as I said in my prepared remarks, we think they're now at somewhere close to 70%, sort of ahead of the 60% that was required for 2019 vehicles. But we expect that just to continue to gradually ramp-up.

I think -- I don't think it's really a question about moving to 100% in 2019 or 2020, but I do believe given the slope of that ramp, we could see 100% adoption well before the 2022 deadline. Exactly when that would occur? Impossible to predict..

Okay. And then also can you just talk about -- I know again you mentioned rig count. Can you maybe give us an idea what the correlation might be with rig count and the oilfield technologies business? Thanks..

Yes. I think historically we like a lot of others who participated in oil field markets have used rig count as sort of a proxy for what's happening. It's become less and less of a good correlating factor simply because rigs have become much more efficient.

Instead of drilling one well from a rig maybe eight 10 years ago now they're drilling three, four, five. So, the better proxy is linear feet drill. There is some information that's available in the marketplace on that that you can find.

But our best available information from talking with our customers is we anticipate linear feet drilled in 2019 versus 2018 is probably going to be flat to maybe down 5%. Now, we've guided our oilfield business as flat.

We think there's a bit of upside for us on the production side, not the drilling side, but also opportunity as we continue to globalize that business..

Okay, great. Thank you very much. Very good quarter and good outlook..

Thanks. We appreciate it..

Next, we'll go to James Sheehan with SunTrust. Please go ahead..

Morning.

Could you discuss the opportunity in Brazil and how you see sales ramping in that market between 2022 and 2025?.

Yes. I think we have some insight there. I'm going to let Ed Woodcock take that one though..

Yes. Thanks Jim. Again as we announced it's starting in 2022 the Brazilian automakers will have to meet a two-day parking requirement. Then in 2023 2024 and 2025 there is an ORVR requirement so a Tier 2-styled canister. Where in 2023 it's a 20% compliance rate 2024 it's a 40% compliance rate and then by 2025 it's a 100% compliance..

Do you guys need new capacity to serve the Brazilian market or do you have enough in the U.S.?.

Yes. At this point, I think we're fine. Things that could drive additional capacity, needs, or any regulations that occur outside of what's already been announced and any benefits that we get from our ANG platform driving additional demand..

Yes. And Jim I would just add that if we were to add capacity it's probably more of the kind that we recently did in Changshu where we put in sort of capital light capital-efficient extrusion capacity converting more of our powdered carbons from purification solutions markets into automotive..

Great.

And could you quantify the impact of higher-cost inventory at Zhuhai and the timing of that?.

Well I think in terms of the timing and working through the inventory we would expect to do that over the course of 2019. I think in terms of getting granular on the cost that's probably somewhere I want to go..

You should see it reversing Jim sort of in Q4..

Yes, I would say if there's concern about the lower EBITDA margins that we posted in the fourth quarter for Performance Materials I would attribute that more to the extended outage that we had at the Covington facility to replace the kiln and somewhat to the higher legal cost more so than the work through of inventory in Zhuhai with the increase we saw in pellet sales for China..

Okay. Last question if I may.

What's the status of your patent infringement suits? Have you gotten any updates on those?.

Well, I get updates on those every week but unfortunately there is never any update. It seems like the legal system continues to move at to glacial pace. So that's frustrating for us. We would like to give resolution. But we've done the hard work of providing the arguments and filings to the court and we just have to wait for it to play out.

There really is nothing significant to report but as soon as we have something we will pass it along..

All right. Thank you very much..

Next question is from Jon Tanwanteng with CJS Securities. Please go ahead..

Good morning, gentlemen. Very nice quarter. Thanks for taking my questions..

Good morning, John..

Expanding on one of the previous questions.

How should we think of the Materials segment margin expansion in 2019, given higher legal cost, higher freight the mix shift to China? And then if there's any similar major plant downtimes on your schedule?.

Yeah. I do think we expect ongoing margin accretion I think maybe slow it a bit by some of the factors that you just referenced. But again I mean some of the things that are headwinds to margins are being offset by just the ramp-up of capacity utilization in Zhuhai, in Changshu.

The fact that we're moving to more sophisticated products, which bring higher margins as these more stringent regulatory requirements are put in place. They require more difficult technology to produce and that favors our business so..

Okay, great. And then are you basing your guidance on any particular start for China this year? And I think I don't think you gave Canada either, although you've provided the U.S.

in your outlook?.

Yeah. For China, our outlook has embedded and it's flat year-over-year sales for light-duty vehicles. So just to put that in context about 24 million vehicles I think..

Okay, great. And then….

Gasoline vehicles obviously..

Got it.

And then just going to Capa, do you have a specific expectation for the contribution on EBITDA in 2019 given you're 1.5 months in and also given its specific seasonality?.

We do, but we're going to report Capa underneath our Performance Chemicals segment. So we're not going to give guidance below the segment level..

Okay. Fair enough. Thank you very much..

And next we'll go to Daniel Rizzo with Jefferies. Please go ahead..

Hi, guys. In terms of Europe you said you saw some maybe potentially some pull-forward there in Performance Materials.

I was wondering if that's been affected at all by the change in -- or the increased testing and the slowdown in production there? I mean, it doesn't seem to have an effect at all?.

I'm going to pass that one to Ed. We're certainly aware of the increased testing requirements but I think the answer is favorable..

Dan, it's not across all of Europe. Meeting the WLTP requirements somewhat OEMs did a terrific job of planning ahead and getting all their models certified under the new test procedures, Volkswagen as an example, struggling to complete the large number of models that they have and get them all certified.

But in general, we've seen a good pellet increase in Europe, reflecting part of the regulatory impacts at the Euro 6d. And I think the automotive OEMs will work through the WLTP issues relatively soon and get back to a normal production schedule..

If we think about Brazil and the ramp it's going to occur there, is it more like the U.S.

pattern where there is like a model year? Or is it more like China where after this date is when you're compliant? How does it work?.

Yes. It's more like China this time. So it's not a model-year based phase and it's an entirety of percentage across the vehicles that are produced..

Okay. And then finally, you mentioned freight cost being potentially a headwind. I was under the impression that freight -- only spot freight costs are kind of declining right now.

I was wondering if that could be a potential tailwind later in the year, as I guess, contracts become renewed?.

It's possible..

Yes. But I think we're taking a conservative view..

Okay. Okay. Thanks..

Next we'll go to Curt Siegmeyer with KeyBanc. Please go ahead..

Hey, good morning, guys..

Good morning.

Good morning.

Given the growth that you cited in 4Q in oilfield and industrial specialties, can you talk a little more specifically, how exactly you're able to leverage the Georgia-Pacific assets just given they've been in the portfolio for a while now to kind of drive that growth and your expectations going forward? I know that you talked a little bit about the rig count, but maybe a little more color around that?.

Yes, great question Curt. I'm going to have Mike Smith take this one..

Yes. Thanks, Curt. First I think that the -- in terms of sales from Georgia-Pacific, they were very much in line with our expectation. The Georgia-Pacific related sales to oilfield grew in a very similar way as ours did overall. I mean, I'd say the same for industrial specialties.

What we were very pleased with as the year progressed was our ability to accelerate the synergy capture and actually increase above our initial expectations. And we did that in a couple of different ways.

We found that our logistics and transportation synergies were really accelerated because we were able to reduce lane miles, reduce storage so that was very helpful.

We were also able through shifting where we made certain products throughout the course of the year, significantly reduce cost that we may have needed to take on an external tolling, especially during the peaks in pavement season, where we certainly sometimes need to go outside and do that.

And that was especially important, because throughout the course of last year the oilfield market was very strong. So the teams really did a great job in looking across the asset base, looking across the logistic base and taking every opportunity to bring forward those synergies to deliver high earnings.

In terms of your comment for oilfield, I think that they are very similar to what Michael described before. We're in close coordination and communication with our customers and just are kind of looking for more of a flat outlook towards 2019 versus 2018 compared to the very strong growth we've had the previous two years..

Our next question is from Paretosh Misra with Berenberg. Please go ahead..

Thank you. So in the Capa business, the new Engineered Polymers business 60% of your CapEx is for growth.

Is that for some specific end market or products?.

I think over the long-term it's really to support the entire business. The expenditures that we have in 2019 are predominantly related to glassware replacement project that's related to the Monomer capacity. This is going to provide some debottlenecking and efficiency.

I think as we look beyond that it's really around investing in additional derivatives capacity. This is something -- we've known the business for a day, so we need to dig into a little bit deeper, but -- and talking with existing management team, which we've already garnered great respect for, they see opportunities.

So we just want to look to understand those and be sure that we're investing properly behind the business..

Got it. And then just on your free cash flow guidance.

If you could give maybe other components of your EBITDA to your free cash flow conversion in other words if the tax -- if the cash tax rate also is 21% to 23% and working capital and those kind of things?.

Yes. Let me look at -- our cash conversion numbers are pretty straightforward Paretosh. I mean, our cash tax rate generally is kind of around 15%, right? So that might help explain some of your disconnect as you kind of work through this.

But you really take the cash from operations the levers are CapEx spend, working capital and obviously taxes drive some of that, right? But for us it's -- working capital is the big lever that we look at very carefully..

Got it. Thanks and good luck for everything..

Thank you very much..

And we'll go to James Sheehan with SunTrust. Please go ahead..

Thanks. Question on Performance Chemicals and your long-term margin target for 2022.

Could you discuss the bridge to that 25% margin target? The impact of $55 oil and how you get there? And also the change -- you're probably adding the Capa acquisition to the business?.

Yes. I think John, this is Michael Wilson. I will have Mike add some color. But I mean, putting aside Capa for a moment, we remain committed to what was the core Performance Chemicals business achieving that 25% EBITDA margin range by 2022. I think we certainly stayed on the cadence of that.

We had sort of a forecast for throughout 2018 and we thought we would hit 20%. We came in at 20.6%. So I think that's right on track. The drivers for what I would call pine chemicals are going to continue to be the mix upgrades continuing to work hard to recover prices to get full value for our prices both at our TOFA based and TOR base.

Now, in terms of what Capa adds, again, you're adding a business that in 2018 had a $175 million of revenue with mid-30% EBITDA margin. So that's going to cause faster margin accretion in Performance Chemicals then was previously talked about before we contemplated Capa. So we'll come back and reevaluate that I think at some point.

And then maybe early next year, we'll come back and do another Investor Day and perhaps reset some of those targets given the evolution of the business.

But Mike, did you have anything you wanted to add to that?.

I think the one other I would add is that the highest margin business excluding Capa within Performance Chemicals is our pavement technology business. And with pavement technology business growing at high single digits, you have an ongoing improvement in margin throughout the overall segment.

Much like we do in that focus on the higher-margin segments within industrial specialty. So that's a natural improvement towards our target of 25% margins..

Thank you very much..

Thank you..

Next question is from Vincent Anderson with Stifel. Please go ahead..

Yeah. Thank you. So you discussed some mild inflation in your feedstock cost for pine chem this year.

I'm just wondering if you're baking in any assumptions for potentially lower HFO prices related to the IMO 2020 regulations? And may be the better question for us is to just remind us, how much of your cost there is implicitly or explicitly tied to heavy fuel oil?.

I think in terms of heavy fuel oil standard, I mean, we probably would face the same thing everybody does as the transportation fuels prices they can go up with the lower sulfur requirements. So we're certainly cognizant of that. And I think that's probably baked into our outlook in terms of our freight and distribution cost.

In terms of the impact of that legislation on our business as a whole, I mean, I think, if anything, there might be a tailwind on asphalt. As asphalt could end up being less costly as that gets implemented. But overall, freight and distribution is less than 5% of our total COGS. So it's not a big new move..

Great. Thanks. And then, you discussed potential growth CapEx related to expanding derivative capacity at Capa. Utilization rates are tough to pin down.

But how much of that portfolio do you think you could shift over the near term before you would need to make any significant derivative investments?.

My understanding is that, it's not something that is going to inhibit our growth over the next couple of years. We have ample capacity to do that. But if we stay on the growth trajectory that we anticipate, in that time period we're going to need to add some additional derivatives capacity.

Where that would be? What exactly that would be, is undetermined. It might necessarily not even be in the U.K.

There's also some possibility that some of our existing reactors and we've already talked about the fact that we have multipurpose reactors that we may maybe able to make some derivatives in reactors that we already have within our chemicals business. So we haven’t had that evaluated. We're only a day in so....

Fair enough. Thank you. Very helpful.

And we'll go to Chris Kapsch with Loop Capital Markets. Please go ahead..

Yes. Just a couple of follow-ups on the pine chemicals business. You mentioned the strong pricing on the TOFA product line. You've also had some pricing initiatives in the market with respect to TOR.

Just wondering if you could describe how those are going? And then also, maybe if you can provide a little more color on the share gains that you mentioned in the adhesives market? Just wondering, especially against the backdrop of lower oil, because the gains I think you said were, vis-à-vis, hydrocarbon-based tackifier.

So is this a function of the G-P colorless technology, tackifier technology? Or something else going on there? Any color would be appreciated..

Sure. Let me take the first part of your question and I'll let Mike answer the second part. I think in terms of related to the TOR and – well the pricing overall as we talked about in the script, we sort of saw low double-digit to low to mid-double-digit price increases across TOFA in 2018. The rosin pricing was more or less flat.

We had certain success in some applications, but not across the board. But we did improved profitability by upgrading the mix by shedding lower-margin business for higher-margin opportunities. And that's something that we'll continue to do. And we'll also continue as I said earlier fight for higher-value prices across that entire product line.

In terms of the adhesives application we picked up maybe Mike can add some color..

Yeah. Sure, Michael. Yeah. So within the adhesive and that's specifically in this particular case for safety road striping we have a large position in that already.

And through close collaboration with a major customer, we were able to take a shift of part of that business where we already had some share that was TOR based and replaced hydrocarbon-based resins based on performance and being cost competitive on a total system at that customer.

So we were able despite the fact that yes oil prices were down to pick up a large piece of share at profitability that we were satisfied with. And certainly higher profitability than other business that we shed in the second half of last year that was low margin in nature specifically inks in Europe..

Very helpful. Thank you..

That will conclude the Q&A session. I'll turn it back to the company for any closing comments..

Thank you everyone for your time and interest this morning. We remain very positive about the long-term outlooks for our business and we look forward to talking with you again next quarter. Have a great day..

Ladies and gentlemen that does conclude your conference for today. Thank you for your participation. You may now disconnect..