Innospec Inc. (IOSP) Q4 2018 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today's Innospec's Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions]. I must advise you that your conference is being recorded today on Wednesday, 20th of February, 2019. I would now like to turn the conference over to your speaker today, General Counsel, David Jones. Please go ahead, sir.

Thank you for joining our fourth quarter 2018 and year-end 2018 financial results conference call. Today's call is being recorded. As you know, late yesterday we reported our financial results for the full-year and quarter ended December 31, 2018. The press release is posted on the company's website innospecinc.com. The slide presentation on the results is now available on our website and both an audio webcast and the slide presentation will be archived on the website for six months. Before we start, I would like to remind everybody that certain comments made during this call might be characterized as forward-looking statements. Generally speaking, any comments regarding management's beliefs, expectations, targets, or other predictions of the future are forward-looking statements. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from the anticipated results implied by those forward-looking statements. These risks and uncertainties are detailed in Innospec's most recent 10-K report, as well as other filings we have with the SEC. We refer you to the SEC's website or our site for these and other documents. In our discussion today, we've also included some non-GAAP financial measures. A reconciliation to the most directly comparable GAAP financial measures is contained in our earnings release, a copy of which is available on the website. With us today from Innospec are Patrick Williams, President and Chief Executive Officer; and Ian Cleminson, Executive Vice President and Chief Financial Officer. And with that, I'll turn it over to you, Patrick.

Thank you, David, and welcome everyone to Innospec's fourth quarter and full-year 2018 conference call. I am pleased to be reporting another very positive quarter for Innospec which completes the most successful year in the company's history. For many years, our vision has been to transform ourselves from a one product company into a thriving profitable global specialty chemicals business. We have successfully achieved this vision to-date and have created very solid foundation from which we will further enhance growth and profitability. Even with the expected decline in our Octane Additives business, we set record revenues of $395 million for the fourth quarter, up 12% on last year and close to $1.5 billion for the full-year, an increase of over 13%. Our businesses have operated in an inflationary environment, but we have continued to manage cost well resulting in adjusted EPS for the quarter of $1.62 another record for Innospec. Excluding Octane Additives, the core businesses are up 25% on the same quarter last year. I am particularly pleased that these improvements in our business have been driven directly by our strategy. We have continued to grow in our chosen markets and we have also delivered significant sustainable gross margin improvements which helped further increase our profitability. 2018 was always going to be extremely challenging year for cash flow. Not only did we need to increase working capital to support the sales growth of our strategic businesses, but we have a number of very exciting organic growth projects which have required capital investment during the year. Despite this outflow, we have delivered excellent cash generation which has brought our leverage down significantly with net debt now at approximately 0.5 times adjusted EBITDA. Fuel Specialties has made good progress this year with strong volume growth driven by continued introduction of new technologies. Gross margin in this business do vary quarter-by-quarter and we're at the lower end in the fourth quarter but they have remained within our expected range throughout the year and we see no reason for this to change in the near future. Performance Chemicals has continued to grow faster than the market, increasing revenue by 12% over the year. It has also delivered a steady improvement in gross margins which we signal would be the basis of our strategy. Our research and technology pipeline delivered further new and exciting products and we have announced investments in our R&D centers of excellence adding a number of new and experienced hires to our highly qualified team. It has been a volatile year for everyone in the oil and gas industry. With these challenges, I am very pleased with the improvements in our oilfield services business. Even as crude oil prices softened towards the end of the year, we have delivered consistent sales growth and full-year sales up 32% on 2017. Our focus on gross margins has resulted in an improvement both sequentially and compared to prior year. Combined with tight cost control, this has helped drive our full-year operating income by more than double over last year. As anticipated, Octane Additives completed the one order from the last remaining customer during the fourth quarter. Full-year sales were little over 50% of the 2017 revenue which was very much in line with our expectations. The outlook for this business is unchanged. We have no orders on hand although we do believe that we will receive one further order in the first half of 2019. Now I will turn the call over to Ian Cleminson who will review our financial results in more detail. Then I will return with some concluding comments. And after that, we will take your questions. Ian?

Thanks, Patrick. Turning to Slide 7 in the presentation, the company's total revenues for the fourth quarter were $395 million, a 12% increase from $353.8 million a year ago. Overall gross margin decreased from last year to 29.5% driven by the reduction in the Octane Additives business and lower margins in Field Specialties. Adjusted EBITDA for the quarter was $55.1 million, the same as the fourth quarter of 2017, as the decline in Octane Additives, and the restructuring charge associated with the closure of our Everberg site, was offset by the improvements in our strategic businesses. Net income for the quarter was $20.4 million compared to a net loss of $4.8 million last year with both periods adversely impacted by U.S. Tax Reform adjustments. Our GAAP earnings per share were $0.83 including special items. The net effect of which decreased our fourth quarter earnings by $0.79 per share. A year ago, we reported a GAAP loss of $0.20 per share which included the negative impact from special items of $1.67. Excluding special items in both years, our adjusted EPS for the quarter was $1.62 per share, a 10% increase from $1.47 per share a year ago despite the decline in Octane Additives. For the full-year, the total revenues of $1.5 billion increased 13% from $1.3 billion in 2017. Net income for 2018 was $85 million or $3.45 per diluted share compared to $61.8 million or $2.52 per diluted share a year-ago. Special items decreased net income for the full-year by $33.9 million or $1.38 per diluted share in 2017. Similar items decreased net income by $52.5 million or $2.14 per diluted share. Excluding special items in both years, our adjusted EPS for the year was $4.83 per share, a 4% increase from $4.66 per share a year ago. Adjusted EBITDA for the year was $187.4 million broadly similar to 2017 despite the declining Octane Additives and the restructuring charge associated with the closure of our site at Everberg. Moving on to Slide 8, revenues in Fuel Specialties for the fourth quarter were $162 million, 11% higher than the $146 million reported a year ago. Volumes grew by 13% offset by an adverse currency impact of 2%. Sales growth was very positive in all regions with excellent volume growth of 16% in the Americas. Fuel Specialties gross margin for the quarter was at the lower end of our expected range at 32.8%, down three percentage points on the comparative quarter last year due mainly to sales mix. Operating income for the segment was $35.6 million, up 12% on the same quarter last year. For the full-year, Fuel Specialties revenues were up 10% to $574.5 million and operating income was up 8% to $116.3 million. Turning to Slide 9, revenues in Performance Chemicals for the fourth quarter increased to $110.4 million from last year's $109.8 million. Sales grew by 1% driven by volume growth of 7%, offset by a price mix effect of 4% and negative currency impact of 2%. Gross margin for this segment was up 1.75 percentage points for the quarter to 20.8%. Operating income for the quarter was $10.5 million broadly in line with the fourth quarter last year. For the full-year, revenues increased 12% from last year to $468.1 million and operating income increased 37% to $44.7 million. Moving on to Slide 10, our Oilfield Services business grew strongly in the fourth quarter despite the softening of the price of crude oil. Revenues were $108.5 million, up 36% on the fourth quarter of 2017 driven by sustained customer activity. Volume growth of 29% was augmented by a favorable price mix impact of 7%. Gross margins improved to 34% up one percentage point from the same period last year and up 1.9 percentage points sequentially. Operating income increased to $8 million compared to $1 million in the same quarter last year. For the full-year, revenues were up 32% to $400.6 million and operating profit was $22.1 million more than double the $9.5 million earned in 2017. Moving on to Slide 11, revenues in Octane Additives for the quarter were in line with expectations at $14.1 million as we delivered the full quantity of the latest order but down from the $18.1 million in last year's fourth quarter. The segment's gross margin was 25.5% driven by the sale of higher volume inventory and higher unit costs due to lower production volumes. Operating income for the quarter was $3.4 million compared to $7.5 million a year ago. For the full-year, as we expected, Octane Additives revenue was $33.7 million, down 43% from the same period last year and operating income was $9.9 million, down from $26.7 million in 2017. Turning to Slide 12, corporate costs for the quarter were within our expected range at $12.3 million, down $1.2 million from the $13.5 million in last year's fourth quarter. The full-year adjusted effective tax rate was 23.7% compared to 20.2% a year ago. Income tax expense was $21.6 million for the quarter compared to $45 million for the fourth quarter of 2017 and both periods include the impact of the U.S. Tax Reform. The full-year charge was $46.6 million compared to $66.3 million for 2017. For 2019, we expect the full-year effective tax rate to be approximately 27%. Moving on to Slide 13, we had a very strong cash flow in the quarter with net cash generated from operations of $69.8 million before capital expenditures of $9.3 million. Operating cash generation for the fourth quarter last year was $47.5 million. There were no share repurchases during the quarter but we paid the previously announced semi-annual dividend of $0.45 per share. This brought the total dividend for the full-year to $0.89 per share representing a 15% increase year-over-year. For the full-year, net cash generated from operations was $104.9 million compared to $82.7 million during 2017. As of December 31, 2018, Innospec had $123.1 million in cash and cash equivalents and total debt of $210.9 million reducing our leverage from around 0.7 times adjusted EBITDA at the beginning of the year to around 0.5 times at the year-end despite significant investments in both fixed and working capital. And now, I'll turn it back over to Patrick for some final comments.

Thanks, Ian. This has been a strong quarter to conclude a very good year, Innospec continued profitable growth strategy. Against the background of challenging markets and with softer crude oil pricing towards the end of the year, we have still been able to deliver record sales in all our strategic businesses. Our adjusted EPS was also at record levels even with the decline in Octane Additives. Excluding this, our adjusted EPS was up 25% on the same period last year, with all our strategic businesses making significant contributions. All of our core businesses have performed well. Fuel Specialties delivered solid volume growth, while the focus on margin improvements in Performance Chemicals has improved profitability as we anticipated. Oilfield Services has not only shown excellent volume growth, but also improved margins which have translated into a substantial improvement in operating income right in line with our expectations. We invested significant amount of cash in both working capital and organic growth projects during the year. But we're still able to deliver great cash flow which has reduced our net debt to around 0.5 times adjusted EBITDA. We have a very strong and solid company with great financial foundations. Our strategy continues to resonate well with our customers as we invest in exciting new technologies. We will continue to focus on growing organically, while having the balance sheet strength to take advantage of any potential acquisition opportunities which will further deliver shareholder value. 2019 has the potential to bring some very tough challenges driven by the instability in the global geopolitical environment. However Innospec has created very solid business foundation from which we can rise to those challenges. We started 2019 with great momentum and optimism and we expect to continue to deliver to our customers and shareholders. Now I'll turn the call over to the operator and Ian and I will take any of your questions.

Thank you. [Operator Instructions]. Your first question comes from Jon Tanwanteng from CJS Securities. Please go ahead, sir.

Good morning gentlemen. Thank you for taking my questions and very nice quarter.

Thanks, Jon.

Thank you, Jon.

Did you see any major swings in month-by-month in oilfield and kind of what drove the overall strength in Q4 especially relative to the decline in crude prices?

Yes. I think, as you remember, Jonathan, our strategy was primarily to relook at the low-risk cost basins. And so we've actually spread out our customer base in those basins. And I think the great technology is just a credit to our management team. We don't get tired. It's continuously efforts to improve not only technology but out in the field. And so it's really hasn't been driven by one technology or one customer, it's been spread out equally among all the division.

Okay great. And have you seen that momentum carrying into Q1 and how do you think of the year?

No, we have. We really haven't seen a slowdown. We saw a little bit edge down in December which you would expect obviously with the Holidays coming about and crude oil prices at that time had slipped quite significant. But with crude rebounding and we typically get to see about three months in advance on some of these crews and we started off fairly strong in the year.

Okay, great. Thank you. Moving to the Chemicals segment, you had a really nice growth rate as you started the year and that kind of trailed off. How should we think of that progression as we go into 2019, what are the year-over-year factors that could contribute to the growth there?

Yes, it's typical in that industry to see some destocking in Q4. Yet you'll see that almost every year and we saw it again in 2018. We would suspect that the growth rates were well beyond the typical market growth rates. So we would suspect a probably 5% to 7% on revenue growth in that business with some increase in the GP and a little bit increase in OI as well.

And Jon, it's just worth noting that in Q4 we did see 7% volume growth year-over-year which is a good indication that the underlying market and certainly our technology is in really good shape.

Got it. Okay. And then, Ian, just help me understand what drove the cash flow in the quarter? Was there anything lumpy or specific or that's going to impact 2019 at all?

No, there is some great management focus. We were a little bit slow in the first half of the year and underlying management team turned their attention to working capital management and cash flow generation and they did a super job. It was accelerating Q3 and Q4 was exactly what we hoped and expected for, so full credit to the guys out there.

Okay, great. And then just one overall comment on input prices, how they've been trending and what do you expect into the New Year?

Input prices? They are pretty steady; I mean they came down briefly when crude prices slipped off. But anything between that $50, $60 range, prices are pretty steady. You're not going to see a jump one way or the other.

Thank you. Your next question comes from Curt Siegmeyer from KeyBanc Capital. Please go ahead, sir.

Hey, on Fuel Specialties, I know you talked about some of the new product launches that seemed to have helped in the quarter drive that double-digit growth, but I was wondering if you could give a little bit more color there especially the Americas region up 16% was pretty impressive, just what some of those drivers were and then how you expect that to -- you always talk about this business being kind of low-single-digit grower over the long-term but you've been able to outpace that for quite a few quarters in 2018. So just wondering if you can talk about that a little bit?

I mean, that business for the life, it's based off technology and continued improvements in technology. And so one of the things that we've introduced is new technology to the market. So we've not only expanded customer base but I think that some of the products that were somewhat falling off in 2017 have picked back up like Chelating. So some of those products have come back to market, some of it is customer expansion and a lot of it really is down to new products and new technologies. And so, yes, we've outpaced the market. I think we're still going to stick to that 2% to 3% above GDP is probably a good number for 2019.

Okay. Can you give us an update on the latest on the GDI opportunity, if there's anything new to talk about there?

You know it's still ongoing. There's a lot more movement, I would say in Europe than there is in the U.S., it's continued to be a technology that will make its way into the market at some point in time, it's making its way into the aftermarket but that's a fairly small market at this point. So really as more GDI vehicles come up out and more PFI vehicles drop off you'll see more of an increase in GDI but it's going to take time. We don't see a lot of big sales into that probably until sometime in 2020.

Thank you. [Operator Instructions]. Your next question comes from Chris Shaw from Monness Crespi. Please go ahead, sir.

Hi, good morning guys. How are you doing?

Good, Chris.

Good, Chris. How are you?

Good, thanks. In the Oilfield services side, the EBITDA this quarter very good, congrats but is that sort of like a base -- I forget is there seasonality in there like a base EBITDA level we could see for quarters sequentially from here?

Yes, Chris, one of the things we've been talking about in our Oilfield Specialties business for a while now is the need to improve the underlying profitability. So there is a feeling that we are hitting EBITDA margins of around about 10% as we exit the year. And our operating margins are in the sort of mid-single-digits of 5.5%, 6%. Our aim is to move the operating margins to around 10% and we're partway there. We exit the year in good shape probably around about 7.5% in the fourth quarter, about 5.5% for the full-year. So there's work to do here. And part of that is the way the market has gone in the last couple of years. And part of that is down to generally pricing from competitors needs to improve. And we need to be mindful of our profitability and our own pricing. So lots of work to do. Very pleased with where we've got the business to, fantastic year-over-year growth but we're not sitting back, we want to go again in 2019.

But there's nothing seasonally strong about the fourth quarter in general. That's a sort of kind of more normal number hopefully that you can keep the margins up?

Yes. Nothing seasonal in the fourth quarter, typically what you see is if you have a strong Q4, you'll drop off a little bit in Q1. But we really have not seen that at all.

Okay. Interesting, but on the Fuels Specialties side was any of that strength you've often talked about in the past, I know it's pretty cold in North America at least where you were -- I was, was any of that the cold flow product, is that some of the move in volume or the strong product mix?

Product mix, you are exactly right, some of that is product mix. So a lot of the CF buying cold weather areas definitely helped that enhancement in growth.

I know people have asked periodically but on the IMO 2020 stuff, I feel like you were getting inquiries in the past. I mean is anything I mean are there real orders out there for products at this point or is it still way too early?

There are orders out there. I think there's still a lot of unknown as to where it's actually be treated, it can be treated at the refinery, at the pipeline, or on the vessel. So there still is a lot of unknowns out there obviously, there's a lot of scrubber technology out et cetera but we're following the market, we are in the market, we're selling products to the market, to the magnitude of how large a revenue potential it's going to be. We just don't know until we know what point of application is going to be.

Got it. If I could just end with the question on the M&A, you mentioned briefly in write-up but I think given [indiscernible] little bit of -- little over time which is a bit rare for you and the balance sheet is obviously quite good, so any thoughts there in terms of what the pipeline looks like?

Yes, I mean I'll try a few things. I mean one of the things that we want to do is have the proper working capital for organic growth because obviously it's your cheapest growth because you're not putting a multiple on it. And we had great projects internally that we're focusing on right now hence why we haven't done a big deal. The other reason why you've seen on the market multiples have been extremely high and we're not going to chase multiples just to chase revenue, it's not the way we operate. So I think for us, it's balancing that program to really look at increasing our dividend which we've done every year and the likelihood is we're going to do that again. We'll focus on the organic growth projects that we have internally and we continue to look in the market for M&A that really fit our portfolio. And if the right thing comes along, you'll see us come out of the market and do something. But as of right now, we just multiples are extremely high and the perfect deal which there is never the perfect deal out there but the right deal for our company is not there quite yet.

All right, great. Thanks for the input.

Thank you.

Thank you. Your next question comes from Jon Tanwanteng from CJS Securities. Please go ahead, sir.

Actually my question was answered. Thank you very much.

Thanks, Jon.

Thank you. There are no further questions at this time. [Operator Instructions].

We can go ahead and conclude.

Thank you very much. There are no further questions at this time. That does conclude our conference for today. Thank you very much for participating. You may all disconnect.