Ingevity Corporation (NGVT) Earnings Call Transcript & Summary

Greetings, and welcome to the Ingevity Performance Materials Webinar. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jack Maurer, Vice President, Public Affairs and Investor Relations. Thank you, sir. You may begin.

Thank you, Jesse. Good morning, everyone. Welcome back to Ingevity's 2020 Webinar Series. We've gotten good feedback about this series, and we hope you are finding them useful. From all of us here at Ingevity, we'd like to express our continued hope, the safety, health and well-being of you and your families. We'd like to express the same for our employees worldwide as we work together through the challenges of the current pandemic. As you may know, we're holding these webinars as a way to continue to inform and educate the financial communities about our businesses. Today, we'll be focusing on our Performance Materials segment. For participants who are logged into our webcast, the slides should be visible in the online viewing pane, and we will be advancing them. Or you can download the slides from the Investors section of our website. You can find it by visiting ir.ingevity.com under Events and Presentations. On Slide 2 of that deck, you'll see our disclaimer that today's webinar may contain forward-looking statements. Relative factors that could cause actual results to differ materially from these forward-looking statements are contained in our SEC filings, including our Form 10-K and our most recent Form 10-Q. Ingevity undertakes no obligation to publicly release any revision to the projections and forward-looking statements made during this call or to update them to reflect events or circumstances occurring after the date of this call. Our presenter today is Ed Woodcock, Executive Vice President and President of Performance Materials. His extensive background, you can see on Slide #3. Ed has been with Ingevity for 32 years. And has been a driving force behind the growth of our activated carbon business. He launched the business's advocacy around gasoline vapor emission control and managed and implemented, the creation of the manufacturing assets necessary to fulfill the business' growth. Ed has steadily risen through positions of increasing responsibility, almost all of which were in the activated carbon business, including technical, sales and commercial management roles. In short, Ed is a highly experienced and extremely knowledgeable leader for this segment and holds a Bachelor of Science degree in chemical engineering from the University of Virginia. On the next slide, you'll see our agenda for the day. Ed will give us an overview of the segment and its products, share an overview of the current regulatory landscape, where we see the biggest opportunities and the direction in which we see gasoline vapor emissions standards heading. How we're going to drive growth? And lastly, Ed will discuss the current state of the automotive industry by region. At the end, he'll offer some perspectives on what we see for 2020 and beyond. After the presentation, we'll open the line for questions. In addition to Ed, Rick Kelson, our Chairman of the Board and Interim CEO and President; and John Fortson, Executive Vice President and CFO, will also be available to participate in the Q&A. We'd like to keep the Q&A at the end of the call focused on Performance Materials. We'll be happy to answer any other questions about Ingevity and our second quarter earnings call is scheduled for July 30. With that, I'll turn the call over to Ed.

Thanks, Jack. Good morning, everyone. In Performance Materials, we engineer, manufacture and sell hardwood-based chemically activated carbon products. Activated carbon is an amorphous disordered form of carbon. Activation refers to the process of developing the pores in the carbon. Globally, activated carbons are predominantly manufactured using a high-temperature thermal steam activation process and carbonaceous raw materials such as lignite, bituminous coal or coconut shells. Instead, our products start with hardwood sawdust and are chemically activated. This difference is what enables our hardwood carbon to provide the performance characteristics which make it uniquely suited for use in automotive gasoline vapor emissions control. We are the leading manufacturer of activated carbons used in this application, and our products are used around the world in cars, trucks, motorcycles, boats and small off-road engines. We have a global reach that allows us to effectively serve our customers through our manufacturing facilities located in the U.S. and China, strategically placed relative to demand. Driven by the promulgation of new regulatory standards around the world and the growth in vehicle sales, the revenue for Performance Materials has increased almost double since 2014, and our EBITDA has more than doubled. At the same time, we continue to drive margin expansion through operational excellence, through supply chain efficiencies and by capturing the value of our world-leading products. We remain very positive about the outlook for our Performance Materials business, and we see continued revenue and earnings growth near-term and long term, which I'll discuss later on in the call. Now let's focus on what we view as our strategic advantages and why the business is poised for even greater value creation. First, we have strong relationships with our customers and deep experience in their applications and end markets. This gives us the ability to anticipate and respond to changing market conditions and customer demands in advance so that we can develop proactive solutions to meet their needs. Second, we are the global experts in gasoline emissions control technology period. And our reputation speaks for itself. Our teams work directly with government and regulatory bodies. In support of our customers, we educate regulators about existing and new technologies that support their objectives or solve specific challenges. We believe the ability to leverage our expertise to educate, advocate and promote regulatory solutions benefits our customers while driving incremental value for our business within those markets. Third, we like to think that we can see what's coming around the corner before our competitors can. Our global engagement with regulators, our customers, with their customers, with suppliers and with the OEMs gives us insight into future trends, engineering challenges and asset needs to support future demand. We are, therefore, an integral part in the process of designing compliance systems for current and future vehicles. We are the leading innovators in this space and use our proprietary technology, trade secrets and confidential manufacturing know-how to create high-performance activated carbon products that meet today's and tomorrow's regulatory standards. We continue to be the preferred provider based on the quality and efficacy of our products, our life of vehicle performance history and our experience of over 40 years in the automotive application of activated carbon. We have never had a product recall. We have never claimed force majeure. We are ISO certified in the automotive industry and undergo frequent qualifications and certifications. As a result, we are widely perceived as the safe, low-risk choice in a risk-averse industry. Lastly, as I mentioned earlier, our activated carbon products are optimally manufactured to both capture gasoline emissions and return them to the engine for their intended use and do so in a way that provides the OEM with the greatest flexibility and minimal canister design. This is important. So let's talk about this a little more. The uniqueness of Ingevity's activated carbon technology is our secret sauce. This is where Ingevity is differentiated among the other players, and this is the fundamental basis of our competitive advantage. Our acid carbon activation facilities are unique and complex. The process uses phosphoric acid as an activation agent to build the exact pore structure that we are targeting. Our processes operate at lower temperatures and higher yields as compared to the thermal steam activation process. But as you can imagine, the combination of phosphoric acid and heat requires a high degree of operational expertise. The upside is that our process provides us more knobs to turn so that we can create a highly porous activated carbon with optimal pore size for capturing and releasing gasoline molecules and minimizing performance degradation over the 15-plus year life of a vehicle required by the OEMs. It is for all of these reasons that any potential entrants into this business would face an uphill battle. Getting into the acid activation carbon business aimed at serving the automotive industry, would require significant capital and a long lead time regarding technical expertise, engineering and reputation. Let's now spend some time talking about the specific systems we develop, manufacture and bring to the market. Ingevity is a global leader in the automotive application of activated carbon. And our solutions are the most cost-effective method to achieve near 0 emissions, which is the standard use today in the U.S. and Canada and the standard to which other countries are heading. We have developed a range of products that enable our customers to use world-leading technology to achieve regulatory compliance and to do so over the life of a vehicle. For fuel tank emissions, our customers design canisters with our granular and pelleted carbons as they provide high capacity and superior durability. Our near 0 solutions include activated carbon honeycombs, bulk media and low-emission pellets to control canister diffusion emissions. And third, our air intake systems are activated carbon sheets and honeycombs used to control engine diffusion emissions. Over the 40-year history of this business, we've installed more than 1 billion units globally. Our products recover more than 8 million gallons of fuel each day, preventing those emissions from damaging the environment. We also produce a number of other activated carbon products for food, water, beverage and chemical purification applications. This enables us to maximize our output and the productivity of our manufacturing assets. Our near 0 automotive solution is covered by our 844 patent, also known as our lead emissions patent. This patent includes 2 components: one, the highly engineered pelleted activated carbons in the canister, which you can see here in purple; and two, one of our proprietary ceramic activated carbon honeycombs affixed through the outlet of the canister, which you can see here in green. It's important to understand that this is a systems patent. Specifically, it covers the use of a high-capacity evaporative emissions canister in conjunction with a low capacity lead device, which in this case is our honeycomb scrubber. The low capacity of the honeycomb scrubber is important as it is effectively entirely scrubbed of fuel vapors when the canister is purged with fresh air. This enables the honeycomb scrubber to capture nearly all the diffusion emissions, migrating from the canister to the scrubber when the vehicle is idle. This patent only applies to U.S. and Canadian vapor emission standards since no other country has yet implemented this near 0 level of regulation. And as you know, the 844 patent expires in March of 2022. We are continually working on potential growth avenues where our core product technology can enable new technology to work. Because of our deep customer relationships with auto manufacturers, we have early insight into where our future engine design is going and the challenges those designs create for evaporative emissions control. Let me use our newest patent family, specifically our new 649 patent or our low-purge canister patent as an example. Low-purge engine systems, including hybrids, are the future of internal combustion engines. Put simply, the biggest difference between current engine models and the future low-purge engines is that there are as less airflow available, which can be either volume of air or time to purge the canister coming into the engine, and therefore, a smaller window for the fuel vapor emissions to be purged. Automakers are interested in this type of design to improve engine efficiency and fuel economy. However, the lower the volume of air, the more challenging it becomes for the canister to be effective. Our 649 patent family is designed to enable canister systems to maintain near-0-emission compliance under these low purge conditions. We believe that our 649 patent currently applies to systems that are on 15% to 20% of U.S. and Canadian vehicles and could apply to anywhere from 30% to 70% of future near 0 fuel system designs. The patent was issued in 2017 and does not expire until 2033. It does not depend on prior art related to our 844 patent. Importantly, we have filed patents for this technology around the world. And while we expect them to be challenged as a matter of course, we will vigorously defend our intellectual property related to low-purge engines. Now I'd like to turn to the broader regulatory landscape. There are 3 tiers of emission standards that are in existence today. OEMs use different technologies to comply with each level of this standard. Importantly, all 3 levels use our unique activated carbon products in varying degrees and quantities. The U.S. first began regulating evaporative emissions in the late 1970s and early 1980s with a Tier 1 canister designed to capture the equivalent of 1 day of parking emissions. In the 1990s, Tier 2 technology was designed to capture multi-day parking emissions and refueling emissions. And more recently, the U.S. and Canada have been moving to a Tier 3 technology which is a near-0-emission solution. The United States adoption of Tier 3 technology is now greater than 80% and will gradually move to 100% compliance for 2022 model year vehicles. There continues to be ongoing shift to more stringent regulations in other parts of the world. China, the world's largest automobile market began adopting Tier 2 systems as part of the China 6 regulatory package last year. The standard was scheduled to be fully implemented by July 2020, but from a production standpoint, we estimate that they achieved full implementation earlier this year. It has driven a 2 to 3x increase in the volume of the canister. It will also drive a technology shift from granular carbon to our higher-value pelleted carbons. Europe also moved to a new regulatory standard last year, known as Euro 6d. This is a Tier 1 technology package. While Europe is moving in the right direction, there is still significant opportunity for improvement. Brazil's new vehicle emission regulation will begin in 2022. And will require capturing 2 days of parking emissions and likely use a Tier 1 Euro 6d canister. Beginning in 2023 and reaching full compliance by the end of 2025, all vehicles must have Tier 2 ORVR systems. But in some cases, depending on the OEM and the vehicle, they may have to use a Tier 3 near 0 system to reach compliance with emission limits on the entire vehicle. Looking to the future, a number of these regions are actively evaluating new regulatory standards. China is evaluating a Tier 3 style standard to continue to drive further reductions in evaporative emissions. Europe is likewise evaluating more stringent regulations that would potentially increase more days of parking control or adding a Tier 2 ORVR requirement. Japan is also evaluating additional emissions control and would likely adopt the Euro 6d standard. We believe we have significant upside potential in these markets in addition to the already favorable macroeconomic growth trends of the global automotive industry. Another way to think about the runway on this business is to consider the magnitude of emissions that are still yet to be controlled or eliminated. On the bottom axis of this chart is latitude, think of it as a proxy for heat, the closer to the equator, the higher the temperature. On the right side of the slide, in purple is the regulatory package that is currently in place or in the case of Brazil, in orange; and Japan, in light purple, where they are moving their regulation to. On the left of the slide is the evaporative emissions generated by a single vehicle in a single year. Using Europe in green, as an example, there are approximately 5 kilograms of evaporated vapor emissions for each gasoline vehicle each year. These yearly emissions are equivalent to 1.9 gallons of gasoline. There are approximately 167 million gasoline vehicles in operation in Europe in 2019. You can quickly do the math and understand the magnitude of fuel vapor emissions in Europe. And as a reminder, Europe just implemented Euro 6d last year. So the amount of fuel vapor emissions per vehicle, per year is much greater than the 5 kilograms that the new Euro 6d vehicles would be emitting. Nearly half of the world's gasoline vehicles are still subject to these antiquated standards. That means that 45% of the world's new gasoline vehicles, over 34 million vehicles are still being regulated to the equivalent of a 1970s U.S. Standard. Only U.S. and Canada, representing less than 25% of the world's new gasoline vehicles annually are on a Tier 3 or near-0-emission standard. As you can see, there is still significant runway for additional regulatory changes around the world. A subject that gets a lot of attention these days is electric vehicles. The use of the term electric vehicles creates a lot of confusion around the growth rate of battery electric vehicles. The term electric vehicles typically includes battery electric vehicles and plug-in hybrid vehicles. Full hybrid vehicles and plug-in hybrid vehicles, both use internal combustion engines. In fact, they are low purge vehicles and typically have a relatively high Ingevity content on them due to their complexity. Using IHS data, it is apparent that battery electric vehicles will be a growing component to the global vehicle mix and that diesel vehicle sales will be heavily impacted. However, based on these estimates, gasoline using vehicles, including full and plug-in hybrids, will continue to be the dominant engine systems for the next several decades at least. Put simply, we believe and the data supports the fact that the death of the internal combustion engine has been greatly exaggerated. We have a significant confidence in the long-term growth prospects for this business, and we are advancing our growth agenda in 3 key areas: regulatory, innovation and commercial. I think it's obvious by now that a stricter regulatory standards are adopted in other countries, the demand for the products we make will increase. Our expertise provides us with the credibility to engage with regulators around the world as they seek to modernize their emission standards. In line with this shift, there will also be a movement for more advanced systems and larger canisters. The products needed to comply with stricter standards, our technology complex to design and manufacture on a commercial level. Our ability to meet these complexities gives us a distinct competitive advantage. So to recap not only do we have the ability to design, manufacture and bring to market a specific technology that will meet these standards, but we have the benefit of having close relationships with our customers to help them understand how to incorporate this new technology into the vehicles they are manufacturing. We intend to continue to enhance our position as global experts with regulatory bodies going forward. We have a history of success in product development and differentiation and believe innovation will continue to be a critical pathway for growth. We will leverage the application of our 649 patent family in the area of new emerging engines, and we intend to expand and maintain our intellectual property as the world's leader in this technology. Never content to sit or rest on our laurels, we are continually working to innovate in this space and have devoted significant resources to the creation of research and innovation centers to advance the science and art associated with these materials and their varied beneficial uses. We plan to continue to leverage our applications, knowledge and customer relationships to target opportunities where we know our products perform well and to create demand for new products. Another exciting example relating to new technology is known as adsorbed natural gas, which is something we feel has the potential for significant future growth. For the same reasons that our carbons win in the evaporative emissions application, our carbons win in this adsorbed natural gas application due to our superior ability to both capture and release hydrocarbon vapors. First and foremost, we are focused on maintaining our reputational leadership with our customers by being the safe and unfailing supplier that we have been for over 40 years. From a commercialization perspective, that means capturing value from our carbons through pricing, which we believe are justified due to the unique value proposition we offer. We also intend to support global harmonization efforts or the elimination of unnecessary differences in regulatory standards around the world. As certain countries move to higher standards, the likelihood of platform harmonization increases. This would help reduce production complexity, drive synergies and technology development and reduce compliance cost, which would help drive revenue growth for Performance Materials. We have negotiated several long-term supply agreements and we'll continue to invest to ensure capacity and supply to meet growing global demand. And as the technology leader in this field, it is not uncommon that others attempt to infringe on our intellectual property, and it is incumbent upon us to defend that intellectual property. To that end, in 2018, we took 2 significant actions against MAHLE and BASF. On the MAHLE litigation, in July 2018, we filed a federal lawsuit alleging that one of our customers, MAHLE, is marketing, manufacturing and selling infringing canisters. The hearing on that suit is expected in 2022 plus. In November 2018, we filed a request with the U.S. International Trade Commission, to prevent MAHLE from importing activated carbons that are used to infringe our 844 patent. We have appealed the decision that the ITC's administrative law judge issued in January of this year, and expect the ruling in early 2022. On BASF, we filed a federal lawsuit alleging that BASF is in the early stages of developing a competitive honeycomb. This premature market -- premature development is an infringement of our patent. The final resolution on that is expected in early 2022. The biggest takeaway from this slide is this. The U.S. patent office has ruled in Ingevity's favor on 3 separate occasions. First, in May of 2019, when they upheld our 844 patent against BASF. Again, in October 2019, in the case against MAHLE. And again, in October 2019, when BASF appealed the patent office's earlier ruling. We believe this validates the strength of our patents and our technology. Our 844 patent remains valid and in full effect until its scheduled expiration in March of 2022. We intend to continue to defend and protect our IP through the court process but it's important to note that if you factor in likely appeals, whatever happens, the legal appeals process will extend beyond the patent expiry. So what's happening in the auto industry right now? The European vehicle market appears to have been more heavily impacted by the COVID-19 and automotive shutdowns than the U.S. or China. Official May light vehicles sales data for Europe are not out yet, but early May data from Germany, France, Spain, U.K. and Italy, indicate a strong improvement off of a very low April. The industry forecast a sales drop of 26% on a full year basis for 2019. The production impacts are very country specific. Spain, France and Italy are impacted more than Germany, Poland and the Czech Republic. And throughout Europe, a return to production really depends on where the auto parts are being sourced. In Europe, as in North America as well, a return to production in April and May did not fully correlate to increased carbon revenue as our customers had to work through their carbon and canister inventories. Diesel vehicles continue to lose share in Europe, in Q1, the gasoline share of the vehicle mix, which includes full hybrids and plug-in hybrids, was 67% and up 180 basis points from prior year. Diesel declined 400 basis points to 28%, and battery electric vehicles increased 230 basis points to 4%. To date, Germany, France and Spain have announced various incentives and stimulus plans. They are mostly focused on incentives for electric vehicles, which include plug-in hybrids, scrapping of older vehicles and purchase tax reductions. We have gained additional volume in Europe due to what we believe to be product supply issues of a competitor. Our current expectation is that European light vehicle sales will reach 75% to 85% of prior year by the tail end of Q3 or beginning of Q4. This is the mid-range scenario we discussed in our call -- our Q1 call. China has had an amazing rapid V-shaped recovery to their auto market. The rapid restart can be attributed to a degree to the production readiness and inventories that were in place prior to the Chinese New Year. All vehicle production plants are operating. And rates are greater than 85% of normal. China had year-over-year vehicle sales increases in both April and May, with May's passenger vehicle sales reaching 1.7 million vehicles, up 7% versus prior. Similar to the U.S.'s July production shutdowns, China typically takes August shutdowns. These have been canceled and will support more production into 2020. China 6 has been fully implemented and will continue to see strong year-over-year revenue generation through Q3 of this year. It's also a challenging year in China for their new electric vehicle or NEV program. These are battery electric vehicles, plug-in hybrid vehicles and fuel cell vehicles. OEMs in China must sell NEVs and generate credits at a required rate each year. At this time, OEMs are less committed to funding money-losing NEV production and sales. In May, NEV production declined 34%, which was the 11th consecutive month of declining sales. The China government is likely to delay or suspend NEV compliance to support the OEMs. 17 cities provinces have introduced vehicle incentives, including increasing license plate quotas and scrappage incentives. Financial institutions were instructed to provide auto financing assistance with lower down payments, lower interest rates and longer terms. The government is as well considering a reduction to the vehicle purchase taxes. Additionally, the strength of the auto market in April and May has encouraged OEMs to be more aggressive with their sales promotion activities. They feel they can increase vehicle sales and minimize their profit loss in the remaining months. Most, especially in the multinational OEMs, have launched very attractive sales promotions in June. The uptick of vehicle sales to avoid public transportation, post the outbreak, provided a near-term sales bump but its ongoing upside is likely to be limited by city car density restrictions. Our current expectation is that China light vehicle sales will continue at or above the 75% to 85% that they reached in April for the remainder of the year. This is well ahead of the high-end scenario we discussed in our Q1 call. U.S. and Canadian April and May vehicle sales exceeded expectations. Sales were, respectively, 52% and 69% of prior year. As I mentioned when discussing Europe, North America's return to production in late April and early May did not fully correlate to increased carbon revenue as our customers had to work through their carbon and canister inventories. The strong sales in May and April and a North American production of only 260,000 vehicles in that same 2-month period drove end of May vehicle inventories to the lowest May level in 9 years. This will support increased production through Q3. July summer model changeover shutdowns will be significantly reduced or canceled or pushed into the back half of 2020 to accommodate near-term increased production. WardsAuto forecast June's production to be at 78% of prior year and at full speed in July despite limitations due to workplace social distancing. OEMs are focusing their production efforts on their most valuable platforms, light-duty trucks and SUVs. These vehicles typically have the highest content of Ingevity's products. Mexican production and supply chain issues have been impacting production restart. Mexico's restarts were delayed into late June or restricted to less than 30% capacity. This impacted parts supply and vehicle production ramp-up schedules as Mexico accounted for approximately 23% of North America's light vehicle production in 2019. Our current expectation is that U.S. light vehicle sales will reach 75% to 85% of prior year by the tail end of Q3, the mid-range scenario we discussed in our Q1 call. In summary, our 40 years of leadership in the application of activated carbon to reduce and eliminate gasoline vapor emissions is unparalleled. We are widely recognized around the world as the experts in this field. In addition, our reputation extends to our manufacturing prowess, our superior quality and consistency provide OEMs the assurance they need in this critical area. There remains significant opportunity globally for new regulations as countries around the world seek to improve their air quality. We will continue to innovate. We will continue to file new patents, and we will continue to defend our intellectual property. This is just something that is part and parcel of operating in a highly technology-driven industry. Lastly, we believe we will continue to deliver outstanding financial results. Specifically, we estimate that in 2021, we should see low double-digit growth. And in 2022, we should see mid-single-digit growth. With that, we'd be happy to take your questions.

[Operator Instructions] Our first question comes from the line of Jim Sheehan with SunTrust.

So your honeycomb scrubber patent that expires in March '22, when that expires, what would you expect your North American market share to look like over the 2 or 3 years following that expiration?

Yes, Jim, we'd still expect it to be strong. As you think through the design and the cycles of vehicles as well as the ongoing 5 to 6 years of each individual vehicle, it's going to take a time for increased competition to probably show up. But we've known this patent has been expiring for 20 years now. It's not like we've sat idle and haven't done anything about the patent expiration. We mentioned that we have some long-term agreements that will support volume going post the patent expiration. In addition, we have our new patents, where it's 15% to 20% coverage today. We expect that percentage to continue to increase. And so we feel very confident about our ability to maintain share and to continue to drive a substantial amount of revenue and earnings from our honeycomb scrubbers.

And can you talk about your market share in both China and Europe? And since you don't have any patents on the Tier 2 product, which is used outside the U.S. Maybe you can talk about why your market position is so strong in places like China and Europe, what's preventing competitors from taking more market share in Tier 2.

Yes, Jim, I would say it goes back to what we discussed today. The technology that we have in our products, the efficacy of our products, the life of vehicle performance of our products and the low-risk and risk-averse industry that we operate in really drives customers to want to use our products to de-risk the opportunities because the penalties, as China as an example, the penalties of noncompliance are very punitive in China. And so all the OEMs and suppliers are really being extremely risk-averse relative to alternative unproven products.

And can you give us a ballpark for what your market share is in both China and Europe?

Yes. I would say, for both, they're relatively high.

Are they as high as they are globally in those regions?

Yes. I'll stand by my first statement. We do have a very high market share in both regions for the reasons that I mentioned.

And can you talk about in your long-term contracts as well as more generally, what's your pricing strategy? And how much do selling prices tend to increase on an annual basis?

Yes. We have a history of annual increases in the low single-digit ranges. And we typically enact those every year.

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

My first one is, in your discussions with regulatory agencies around the world, have pandemic or recessionary concerns pushed out the potential timetable for stricter standards at all? Have you seen that? And if so, where or if people are considering, what are they thinking about?

If I think about the China, China is moving forward regardless of what the issues are. They have a serious emissions issue, and then they're moving forward to address it. And I haven't seen any consideration of delay in that. Europe as well is continuing to look at the alternatives that we discussed. Obviously, the automotive companies would prefer to push it out. But at the same time, as you can see in Europe in the summer, they still have a very large pollution issue and continue to move forward and need to address that. But I don't see any delays at this point. But the automotive companies under some profit pressure would probably try to push back on them as much as they can, but at the same time, the opportunities and what they need to do to drive further reductions in emissions are rather large.

Understood. And assuming China does go to Tier 3 by mid-decade, given that you've never had a patent there for Tier 3 in the first place, what are your expectations for market share there? And kind of what can you expect from the offsets in terms of levers and long-term contracts and just the ability to supply the industry?

Yes. We -- our new patent family, the 649 patent, we do have patent coverage in that region. And as you can imagine, China as well is moving towards low-purge engines, and we expect that patent to have application in China.

Got it. Okay. A quick one on just hybrid versus normal vehicles. What is the content or Ingevity content in a new hybrid vehicle versus a gasoline vehicle of the same size today? Is it higher or lower or roughly the same?

Yes. I'd say it's higher. And it's typically you've got a canister -- pelleted canister system in it, but you're likely to have multiple honeycombs instead of just single honeycombs within those systems.

[Operator Instructions] Our next question comes from the line of John McNulty with BMO Capital Markets.

So with regard to the potential new regulations, I mean, certainly, the Japan one is, the duration is -- or at least when you're looking for it, it's actually pretty soon. Like when do you expect to get an update on that? Because I would imagine you have to almost start production almost imminently if you're talking a 2021 type time frame. So how should we think about that?

Yes, we expect that to be clarified by the back end of this year.

Got it. Okay.

And it's effectively a shift for them from the lower value granular carbons to a kind of a Euro 6d canister. So it's an increase in the size of the canister, but also a shift to pelleted carbons. And we also see -- we also see some harmonization opportunity there. Japan exports a number of vehicles into Southeast Asia. It makes sense for them to stick to one type of canister system and then trying to put multiple different canister systems on those vehicles.

Sure. No, makes sense. And then your confidence level on -- because I think it's the first time I've seen you guys at least try to quantify the timing on China and Europe. I guess your confidence level that those happen roughly in that time frame? I guess where is that coming from? Is it just recent conversations with some of the regulators? Is that how we should be thinking about that?

China as an example, if you think of the 5-year plans that they have, regulatory action typically, it kind of is mirroring those 5-year plans. And so the next plenary is 2025. And so typically, China will make announcements towards the next 25 years of what they'll be moving forward with. But if I look back at the last regulation, there's lots of conversation that goes with their EPA with the automotive manufacturers to make sure that they're ready for that change. So as we engage with them and continue to work with them on the next round of regulation, we still feel very confident that time frame is doable and would be achievable for China.

Got it. Okay. And then I guess to that, like -- and with the Japan one as well, potentially on the com, I guess, how should we think about how much incremental capacity you would need to meet some of the demand here? I know you just put in some new capacity in China, so maybe that's not an issue at least for any of the Tier 1, Tier 2 type potential growth. But I guess, how should we be thinking about that and what the cost might be to put in any incremental capacity?

Yes. We feel good about the capability that we have to meet that demand. If you think about the process purification aspect, a portion of our business, that's powder and activated carbon. It's also future automotive product and that we can take that product and extrude it into pellets. So for us, it's not really having the volume of activated carbon available. It's just making sure that we've got the extrusion facilities to be able to convert that product to a higher value.

Got it. And the cost of extrusion capacity, I assume that's pretty minimal. Is that a fair way to think about it?

With the technology that we have, yes, it's very minimal.

Got it. Okay. And then I guess, just the last question. So the margin progression that you guys have seen in the business over the last few years has been pretty rock solid. I guess, as you look out over the next 2 to 3 years, when you kind of include the puts and takes of continued pricing and potentially more volumes, whether it's coming out of Japan or Brazil, where that starts to roll in versus at the same time, maybe you do have to give a little bit back around the patents just to keep customers happy. How should we think about the margin progression as you're looking out over the next few years for this business?

We still think it will have a positive slope. It likely won't be the slope that you see on that graph, but we do feel we'll continue to be able to accrete on margins.

Our next question comes from Paretosh Misra with Berenberg.

Just curious, what is the difference between China 6 that they currently have right now and U.S. Tier 3, is it just the honeycomb or the quality of the activated carbon also is different?

Yes. It's primarily going from some emissions to near 0 emissions and using scrubbing technology to kind of drive that overall canister emissions technology down to 0. For China, you need to remember that there are multinational OEMs that are in the market as well. So they have the technology and understand how to develop and install Tier 3 systems. And then likewise, we're -- our applications team in China is working with all the OEMs in China as well and helping them understand how to do Tier 3 systems and what kind of content they need to reach those potential near 0 requirements.

Got it. And how superior is your product performance. Is there a way to kind of quantify it, like in China, can your competitors make a product that maybe is good enough for Tier 1 regulations or they're not there yet?

Yes. We do have a competitor in China. What our value is, is the life of vehicle performance. Other competitive products typically have a greater degradation of the carbon over that 15-year life. If it has more degradation than our products, then that means you've got to build a bigger canister with that competitive product so that you can still achieve that same life of vehicle performance at the end of 15 years. So our durability, what we call, how it works effectively year-over-year over year, and how it ages over those 15 years is minimal. And really is the world-leading kind of technology that others have yet to be able to mimic.

And the feedstock is the same between U.S. and China? Or is it different? The feedstock to make activated carbon.

Yes. Well, even within our manufacturing facility, so we have 2 activation facilities in the U.S., one in Covington and one in Wickliffe, both of those use hardwood sawdust as their raw material. We have a facility in China that is using a different type of wood, and we still effectively make our high-value products with the same aging profile that I talked about with that wood source that we are using in China. And I think that's a key part of our technology of being able to adjust our processes but still achieve world-leading products.

I see. And, I guess, just a last one. Just going back to the long-term contract in the U.S. that you talked about earlier. I don't know if you tried to quantified it like how -- what percentage of the U.S. volumes are currently tied to these long-term contracts?

Yes. I would say it's less than 50%.

Thank you. It appears we have no additional questions at this time. So I'd like to pass the floor back over to Mr. Maurer for any additional closing comments.

Thanks, Jesse. Thank you very much, everybody, for joining us this morning. I hope you found this informative. Before we conclude today, I want to announce that our next webinar on the topic of sustainability will be held at 10:00 a.m. on July 23. This is a change from the date that we announced back on March 24, when we announced the series. We've made this change due to a scheduling conflict. So again, the sustainability webinar will be held on July 23. We'll be issuing a news release later today on that page. So thank you very much for joining us this morning and thank you for your interest in Ingevity.

Ladies and gentlemen, this does conclude today's webinar. Once again, we thank you for your participation, and you may disconnect your lines at this time.