Innospec Inc. (IOSP) Q2 2019 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today's 2019 earnings conference call. [Operator Instructions] I must advise you that this conference is being recorded today, Wednesday, 7th of August 2019. I would like to hand the conference over to your speaker today, David Jones, General Counsel and Chief Compliance Officer. Please go ahead, sir.

Thank you. Good day, everyone. My name is David Jones, and I'm Vice President, General Counsel and Chief Compliance Officer at Innospec. Thank you for joining our second quarter 2019 financial results conference call. Today's call is being recorded. As you know, late yesterday, we reported our financial results for the quarter ended June 30, 2019. The press release is posted on the company's website at www.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 site 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 under the Private Securities Litigation Reform Act of 1995. 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 Innospec 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 second quarter 2019 conference call. We are pleased to report another good set of results, which underlines the strength of our strategy and the value of operating with a balanced portfolio. Our core businesses have all performed well during the quarter, most notably our oilfield services business, which has delivered another excellent performance. This quarter, once again, had minimal sales in octane additives compared to the previous year. Excluding octane additives, our operating income increased by 37% and our adjusted EPS is up 40%, which is impressive by any standards. I'm delighted to open with remarks relating to oilfield services. This has been an excellent quarter on both revenue and margins. We delivered sales revenue up 29%, which is better than most in the industry. Our continued focus on improving margins is delivering, with gross margins moving up close to 34%. In addition, with continued cost control, this has translated to operating income which has more than doubled to over $10 million for the quarter. Performance chemicals had a solid quarter, and we remain ahead of schedule against the strategic targets we set out almost three years ago. Sales revenue was down, but this was mainly attributed to lower selling prices driven by a pass-through of lower raw material cost in our contractual business. However, once again, our focus on margins has delivered a further improvement which has resulted in operating income increasing over 13%. The business continues to develop and market very attractive new products, which are well aligned with consumer trends. Fuel specialties sales and margin were broadly flat on a strong comparative quarter. The business suffered a minor disruption to supply and operations in the U.S.A. during the quarter due to a supplier's outage. Our team has worked hard to minimize this issue and return operations and customer service back to normal. These actions have ensured that there are no long-term implications. As previously indicated, sales in octane additives were minimal in the quarter, so operating income was down $5.1 million on the same period last year. So overall, given the headwinds, this has been a very good quarter for Innospec, showing that we have a very sound and strategic foundation for further organic and acquisitive growth. 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. After that, we will take your questions. Ian?

Thanks Patrick. Turning to Slide 7 in the presentation. The company's total revenues for the second quarter were $362.4 million, a 1% increase from $358.1 million a year ago. The overall gross margin increased 2 percentage points from last year to 30.7% driven mainly by improved margins in oilfield services and performance chemicals. EBITDA for the quarter was $43.8 million, up slightly on last year. Our GAAP earnings per share were $0.90, including special items, the net effect of which decreased our second quarter earnings by $0.22 per share. A year ago, we reported GAAP earnings per share of $0.89, which included an adverse impact from special items of $0.11. Excluding special items in both years, our adjusted EPS for the quarter was $1.12, a 12% increase from $1 a year ago, demonstrating the value of our strategic businesses and the strength of our overall portfolio. It's worth noting that the results were impacted by around $0.06 due to higher share-based compensation accruals and by approximately $0.20 due to a lower octane additives contribution. Even with these headwinds, the business has posted some impressive results. Moving on to Slide 8. Our oilfield services business has delivered excellent results in the quarter. Revenues of $122.5 million were up 29% on the same period last year driven by good customer activity in both stimulation and production. Customers are continuing to find our combined technology and service offering very attractive, and our market share continues to grow. Gross margins improved 3.8 percentage points as the sales mix improved in the quarter. As we previously indicated, the growth and margin improvements, combined with good cost control, has generated a substantial improvement in operating income, which is up to $10.1 million for the quarter, compared to just $4.1 million in the same period last year. Turning to Slide 9. Revenues in performance chemicals for the second quarter were $104.7 million, down 12% from $118.9 million a year ago, driven by a 5% reduction in volumes, a negative currency impact of 4% and an adverse price/mix of 3%, as reduction in raw material prices translated into lower selling prices. Despite the reduced revenue, we have further improved margins as part of our long-term strategy with gross margins up 2.9 percentage points. Operating income was up 13% to $11 million from $9.7 million in the same quarter last year. Moving on to Slide 10. Fuel specialties produced a very solid set of results in the quarter, right on our expectations. Revenues for the second quarter were $133.3 million, down by 1% from last year, as a positive price/mix of 5% was offset by an adverse currency impact of 4%, combined with a 2% reduction in volumes. Gross margins of 33.5% were similar to the comparative period and within our expected range. Operating income was up around 1% to $24.1 million. Moving on to Slide 11. In octane additives, revenues for the quarter were $1.9 million, compared to $10 million a year ago; operating income of $0.1 million, compared to $5.2 million in last year's second quarter. We are currently working to fulfill an order of approximately $6.5 million which we booked in Q3. Beyond this, we have limited visibility as our expectation is for one smaller final order in Q4. We will continue to update you on these quarterly calls. Turning to Slide 12. Corporate costs for the quarter were $13.6 million, compared to the $14.4 million recorded a year ago. The effective tax rate for the quarter was 26.9%, similar to the 26.1% of last year, driven by the geographical location of taxable profits. Moving on to Slide 13. Net cash provided by operating activities in the quarter was $50 million, compared to $2.3 million a year ago. In the quarter, the company also distributed $12.2 million to shareholders for the semiannual dividend. As of June 30, 2019, Innospec had $106.1 million in cash and cash equivalents and total debt of $160.9 million, moving our net debt position to approximately 0.3 times EBITDA. I'll now turn it back over to Patrick for some final comments.

Thanks Ian. Despite some significant challenges in the quarter, we have once again produced a strong set of results with good underlying growth in earnings and excellent cash generation. Excluding our octane additives business, our core operating income grew by 37%. Oilfield services had a particularly strong quarter. We are ahead of our expectations on revenue growth, and we continue to slowly improve margins. This resulted in a 146% improvement in operating income compared to the second quarter of 2018 and is a testament to the great job the oilfield team has done. While performance chemicals revenue were impacted by lower raw material prices, I am very pleased with their continued improvement in margins, which is aligned with the goals we set back in 2017. The development of new technology continues to be the backbone of success in this business, and we have confidence in its future growth prospects. Fuel specialties had a quieter period after two quarters of good revenue growth, but the business remains right on track and margins are in the normal range that we would expect. The business had to deal with a significant supplier outage during the quarter, and I'm delighted with the way our team developed alternative arrangements to minimize any disruption to our customers. We had a very strong quarter for cash flow with an operating cash inflow of $50 million, which has helped to further strengthen our balance sheet. Net debt is approximately 0.3 times EBITDA. This compares to 1.7 times EBITDA at the end of 2016 when we made our last significant acquisition. At the very end of the quarter, we faced an additional challenge in the form of a cybersecurity incident, which we understand has impacted hundreds of companies and organizations across the U.S.A. While this has caused some short-term disruption to our communications, we have continued to produce product throughout and we are well on our way back to normal levels of service. We do not expect any long-term impact. I would like to take this opportunity to thank all of our customers, suppliers and employees who have supported us through this difficult period. Our key organic growth projects remain on track and are well positioned to acquire when we are confident of adding shareholder value and the multiples are acceptable. With good fundamentals, a strong pipeline of organic growth projects and potential for further acquisition growth, we feel very confident about our future. Now I will turn the call over to the operator, and Ian and I will take any of your questions.

[Operator Instructions] And the first question is coming from the line of Jon Tanwanteng. Please go ahead.

My first one is, Ian, can you quantify the impact of the stock comp accruals on the operating and net income this quarter?

Yes, Jon, as we said on the call, it's around about $0.06. That translates into broadly about $2.5 million at the operating income level. So yes, it's a significant impact. We saw a run up in the stock price right at the end of the quarter by about 9%. That's come off a little bit in the July period and into August. As you know, it's just mark-to-market, so yeah, it's a couple of million to $3 million.

And then also on the raw material disruption, can you quantify what kind of a headwind that was in Q2 and if there was anything that will lead to the Q3?

Is that specifically in performance chemicals, Jon?

The supply disruption that you had, I think, in North America.

I'm sorry, North America, okay, yeah. It's a little bit difficult to say. I think what I would say, and I'm sure Patrick will come over the top on this one, is that we've done a great job in managing our inventories as best we can. It's really a matter of timing. I think we've managed to keep most of our customers supplied. And as we've worked our way through it, we have managed a little bit hand to mouth in some places. But I don't see a major impact in Q2. I think as we work through Q3, I think we may see a little bit of impact, so I think it will be Q4 before we get back to normal.

Yes, Jon, I think Ian is correct. We're starting to come out of this. It was a couple of raw materials for oilfield and for fuel specialties, but it looks as if we can see the light now. We're manufacturing some of the products at our sites, and we have found alternative sources for the remaining products. And it looks like by Q4, we should be in the normal operations.

Is that going be mostly a margin drag? Or how do you expect it to play out?

No, I don't think it's going hit margins at all. As a matter of fact, over time, it might improve margins, pulling some of this back on our facilities and in alternative areas that we're looking at supply. So I think over time, it possibly could improve margins on those specific products. But I would keep the margin lines that you have for fuel and oilfield right where they are.

And then finally, and I know there's a lot of these weird impacts in the quarter. The cyber-attack, what's the damage posted from a lost sales perspective, if any, and the cost to fix it? Is everything up and running now the way you wanted?

Yes. It's hard to quantify right now. Obviously, it's insured, which is a good thing for us. But we are back up and running. And again, we should be back to normal operations anytime. We never stopped shipping products. We never stopped making products. We never stopped invoicing, collecting cash and/or paying vendors. So as of now, it looks as we should be back up to normal operations probably by the end of this week.

Was there a deductible or anything before this insurance pays out?

Yes, small deductible.

And I'm looking at Q3, the oilfield business, obviously, you've done very well there. What were the main drivers there of that sequential improvement? And can you sustain that? And - or could it even improve it, given what you're doing?

Some of its raw material costs have come down. A lot of it is technology, that we provided new technologies to the marketplace. And it's really, I think, it's the focus that our people have on driving margin, the margin profile that we've stressed the last two years, controlling cost and getting good revenue. And what we mean by good revenue is recurring revenue with a strong product portfolio. And that really has put us in a good position, and that's put us in a good future position as well for new products that we're bringing to the marketplace. So we're pretty confident, even where oil prices are today, that we can still post positive growth.

Finally, just any update on IMO 2020? How you see that fleshing out? I know you had some impact last quarter - or benefit rather. Are you continuing to see that? Is it improving? And can you give us a little more clarity on how 2020 will shape out from products you can sell into that market and kind of how you're prepping refineries now?

Yes, good question. So right now, what we're seeing is the tank cleaning portion of our business for IMO 2020. So everybody is preparing their tanks for this new fuel. And so a lot of that is cleaning up the tanks and the current sludge you have in the tanks. And that's where we're seeing the benefit right now. And where it goes in 2020? Jon, we're just not quite sure. Is it going to be treated at the terminal? Is it going be treated on the ship? Is it going be treated at the refinery? Where is the actual treatment going come from? And what are the actual problems going be? We have a general idea when the U.S. went to ULSD and the problems associated with ULSD. And you'll have similar problems when you go to this new fuel for IMO 2020. But again, it's kind of premature to say what it's going look like, what the fuel is going look like and where the actual treatment will be. The good thing is where ever it gets treated, whether it's on the vessel, whether it's in the pipeline or whether it's at the refinery, we can treat at all three locations. So we're very well positioned. I think it's kind of a wait and see, Jon. I think a lot of people are going be scrambling at the last minute.

The next question is coming from the line of Chris Shaw. Please go ahead.

Just more questions on oilfield. I think you mentioned you're outgrowing the market. A couple of questions just with that. One, like how fast is the market growing? Or maybe how fast are you outgrowing the market? Are you getting in that through market share or just that your customers are growing that much faster than some of the others?

It's a little bit of both. Some of it is market share, Chris. Some of its organic growth within our current customer base. And again, I would tell you, as I alluded to earlier on the earlier question, is that we're selective into who we partner with due to the fact that our technology, we think, is superior. And we need to make sure we deliver the service that we promised to our customers, and we can't do that for everybody. So we're very selective in who we grow with. We provide excellent customer service and excellent products, and that's enabled us to further enhance our growth. And I don't see that changing near term even though crude oil prices have slipped down the low 50s. So I think it's kind of a - it's a quarter by quarter to see where crude prices go and what happens at that point in time.

I was going ask about the oil. So do you see your customers won't slow down in a lower price oil environment? I mean are they - I mean what - I know you have a pretty good take usually on the exploration market or the oil market itself. So I mean is it bad? Or do you just think your business will continue to grow through providing more products, better technology, higher prices as such, if oil does continue to stay this low?

Yes. No, it's interesting. I think what you'll see is if crude keeps sliding down below that $50 barrier, you could see some downturn in the market in regards to drilling and completions, primarily completions. There's still a lot of wells behind pipe that haven't been completed. So I think you'll see a little bit of slowdown in that if it keeps slipping. So we're prepared. We've, obviously, been through it before. I think the basins that we strategically concentrated on early on when we developed this business puts us in a much better position to where most of our customers still will drill and complete a fair quantity of wells. So I think we positioned ourselves very well. And obviously, this business is not just based in the U.S. We've now developed some business in the Middle East. We have some business in South America. So we've really balanced out the portfolio to not just concentrate on U.S. basins, and I think that's going benefit us as well.

And then slightly on, say, M&A. I mean what's the latest sort of outlook for that? Is the - are the multiples still too high in the pipeline? And what are you seeing?

Yes, there's a lot out there. Multiples are starting to come down. So we are starting to see a retraction on multiples. We've looked at a lot of deals. We continue to look at a lot of deals. Obviously, it's got to fit our portfolio. It's got to fit our - exactly what we're doing from a strategic standpoint for the future. I think you should see something from us, hopefully, sometime this year. I'm not sure you're going see any big deals come out of us anytime soon. I think from that standpoint, there's too many people still chasing deals that we feel are overvalued. So we're in a great position to not only increase dividend but also to fund the organic growth projects that we have and still grow this business. We're not in a position where we have to acquire anymore. So if the right deal comes along, we'll buy it. If it doesn't come along, we're going focus on organic growth.

[Operator Instructions] The next question is coming from the line of Jon Tanwanteng. Please go ahead.

Just a quick follow-up from me. Ian, what's your expected SAR operating expenses here?

For the full year, Jon?

Yes.

I think what we had in the model was probably about $280 million, excluding R&D, so --

2-1-8?

2-8-0, excluding R&D.

2-8-0, got it. Okay. And does that include the impact of further stock comp accruals or reversals given where the share price is now?

It doesn't include any increase or decrease, Jon. We'll just have those in the quarter.

There are no further questions at this time. I'm handing over the call to Patrick Williams for final comments. Please go ahead, sir.

Thank you all for joining us today, and thanks to all our shareholders, customers and Innospec employees for your interest and support. If you have any further questions about Innospec or matters discussed today, please give us a call. We look forward to meeting up with you again to discuss our Q3 2019 results in November. Have a great day.

That does conclude our conference for today. Thank you for participating. You may all disconnect.