Innospec Inc. Q4 FY2022 Earnings Call

Good day, and thank you for standing by. Welcome to Innospec's Fourth Quarter 2022 earnings release conference call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to our first speaker today, David Jones, General Counsel. Please go ahead.

Thank you. Welcome to Innospec's fourth quarter earnings call. This is David Jones and I'm Innospec's General Counsel and Chief Compliance Officer. The earnings release and this presentation are posted on the Company's website. During this call, we will make forward-looking statements which are predictions, projections, and other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from anticipated results implied by such forward-looking statements. The risks and uncertainties are detailed in Innospec's 10-K, 10-Qs, and other filings with the SEC. Please see the SEC site and Innospec's site for these and related documents. In our discussion today, we've also included non-GAAP financial measures. A reconciliation to the most directly comparable GAAP financial measure is contained in the earnings release. The non-GAAP financial measures should not be considered as a substitute for or superior to those prepared in accordance with GAAP. They are included as additional items to aid investor understanding of the Company's performance in addition to the impact that these items and events had on financial results. With me 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 2022 conference call. I am pleased to present another very strong set of results for Innospec. Our balanced portfolio achieved excellent overall operating results in the quarter. Strong activity in Oilfield Services and steady results in Fuel Specialties offset the effect of aggressive year-end destocking in Performance Chemicals. Overall, operating income was up 31% in the quarter and 42% for the year with margin expansion. Performance Chemicals had an excellent year despite the impacts of customer destocking in the fourth quarter. The business delivered strong operating income growth and margin expansion with full-year operating income up an impressive 34% over 2021. Destocking was mostly in our U.S. Personal Care business and lower volumes and higher-cost inventory drove a negative product mix and lower margins in the quarter. We expect this to continue in the first half of 2023. However, new customer projects are on track, and we remain optimistic that volumes will normalize in the coming quarters, and we will return to volume growth in the second half of the year. In addition, we're very excited about our increasing prospects in our agriculture, mining, construction, and other industrial end markets, which collectively registered double-digit profit growth in 2022. In Fuel Specialties, operating income grew by 4% over the same quarter last year and by an impressive 16% for the full year. Gross margin continued to track below our target of 32% to 35% range. The primary impact on margins has been the lag between price action and input cost inflation, in particular in the EMEA region, where inflation remains very high. We expect margins to stay below our target range in the coming quarter, but returning to margins back into our target range is a significant opportunity and priority for the business in 2023. Over the medium to long term, we'll remain well positioned to help advance our customers' priorities to lower carbon footprint, deploy cleaner fuels and drive operating efficiency in both transportation fleets and non-fuel applications. Oilfield Services had an excellent quarter and record full-year operating income. Production Chemicals continue to have very strong order activity in the fourth quarter, which drove a strong significant sequential increase in operating income. In the coming quarters, we continue to anticipate that a portion of these production sales will moderate. However, we expect further top line and margin improvement in our other Oilfield Segments, and we remain very optimistic that we can deliver sequential full-year operating income growth in 2023. Now, I will turn the call over to Ian Cleminson, who'll review our financial results in more detail. Then I will return with some concluding comments. After that, Ian and I will take your questions.

Thanks, Patrick. Turning to Slide 7 in the presentation. The Company's total revenues for the fourth quarter were $510.7 million, a 24% increase from $413.2 million a year ago. Overall, gross margin increased by 2.4 percentage points from last year to 29.7%. EBITDA for the quarter was $54.3 million compared to $44.8 million last year, and net income for the quarter was $25.5 million compared to $23.9 million a year ago. Our GAAP earnings per share were $1.02, including special items, the net effect of which decreased our fourth quarter earnings by $0.18 a share. A year ago, we reported GAAP earnings per share of $0.96, which included a negative impact from special items of $0.34 per share. Excluding special items in both years, our adjusted EPS for the quarter was $1.20 compared to $1.30 a year ago. In the quarter, our EPS also included an adverse impact of $0.36 due to higher tax charges, primarily arising from operations exposed to foreign currency fluctuations. For the full year, total revenues of $1.96 billion increased 32% from $1.48 billion in 2021. EBITDA for the year was $225.4 million compared to $178.2 million in 2021 and net income was $133 million compared to $93.1 million a year ago. Our full-year GAAP earnings per share were $5.32 including special items, which decreased our full-year earnings by $0.72 per share. In 2021, we reported GAAP earnings of $3.75 per share, which included a negative impact from special items of $1.05 per share. Excluding special items in both years, our adjusted EPS for the year was $6.04 compared to $4.80 a year ago. Turning to Slide 8. Revenues in Performance Chemicals for the fourth quarter were $143.9 million, up 4% from last year's $138.4 million. Our positive price/mix of 18% was offset by a 5% volume decline and an adverse currency impact of 9%. Gross margins of 18.4% were down 3 percentage points from last year, impacted by lower production volumes due to customer destocking and high raw material costs, primarily in the U.S. Operating income decreased 7% from last year to $15.8 million. For the full year, revenues of $639.7 million were up 22% from last year's $525.3 million, and operating income increased by 34% to $95.3 million. We have continued to see the volume impacts of customer destocking and lower demand in the first quarter. We currently expect volumes and gross margins in the first half of 2023 to be significantly below the comparative prior year levels. However, as trading levels normalize and new customer contracts come online, we remain confident that we can deliver comparative period volume growth in the second half of 2023. Moving on to Slide 9. Revenues in Fuel Specialties for the fourth quarter were $183.3 million, 2% higher than the $179.5 million reported a year ago. A favorable price/mix of 25% was offset by a reduction in volumes of 14% and a negative currency impact of 9%. Fuel Specialties gross margins of 27.8% improved slightly from 27.4% last year and will remain at the lower end of our expected range until inventory costs moderate and inflation normalizes. Operating income increased 4% from last year to $26.8 million. For the full year, revenues were up 18% to $730.2 million, and operating income increased 16% to $121.7 million. Moving on to Slide 10. Revenues in Oilfield Services for the quarter were $183.5 million, up 93% from $95.3 million in the fourth quarter last year. Very strong orders in production chemicals and the sequential recovery in other segments continued. Gross margins of 40.4% were up 4.5 percentage points on last year's 35.9% and operating income of $20.5 million was a $16.2 million improvement from a year ago. For the full year, revenues of $593.8 million were up 75% from last year's $339.8 million, and operating income of $41.7 million quadrupled from $10.4 million last year. Turning to Slide 11. Corporate costs for the quarter were $16.5 million compared to $13.2 million a year ago due mainly to higher performance-related remuneration accruals. The full year adjusted effective tax rate was 27% compared to 22.7% a year ago. The increase is primarily a consequence of having operations outside of the U.S. where they are exposed to foreign currency fluctuations. This and other items have caused an increase in the tax rate in the year and specifically in the fourth quarter, causing a $0.36 negative impact on earnings per share. For 2023, we expect the full-year effective tax rate to remain at 28%. Moving on to Slide 12. This was an excellent quarter for cash with cash generated from operations of $78.4 million before capital expenditures of $15.1 million. In the quarter, we paid the previously announced semi-annual dividend of $0.65 per common share. This brought the total dividend for the full year to $1.28 per share, a 10% increase over 2021. For the full year, cash from operations after net capital expenditures was $39.6 million compared to $57 million during 2021. As of December 31, 2022, Innospec had $147.1 million in cash and cash equivalents and no debt. And now I'll turn it back over to Patrick for some final comments.

Thanks, Ian. Our business teams delivered excellent operating results in the quarter and the full year. All businesses contributed meaningfully to our strong double-digit growth. In 2022, we proactively made the decision to hold higher inventories in our Performance Chemicals and Fuel Specialties businesses in order to ensure reliable, uninterrupted supply for our customers. This higher-cost inventory impacted margins in the final quarter, and we expect this to continue to be a short-term headwind in the first half of 2023. In partnership with our customers, we will continue to lead with innovation, supply reliability, and best-in-class technical service. Our competitive position is strong in the end markets that we serve and the fundamental medium-to-long term drivers of our strategy are unchanged. Our balanced portfolio will continue to deliver shareholder value despite any short-term headwinds. Cash flow was extremely strong in the quarter, and our net cash position improved to over $147 million. In 2023, we expect to complete the majority of our $70 million Performance Chemicals expansion program, which is focused on our leading mild and natural personal care technologies. With our strong balance sheet, we are well positioned to pursue M&A that complements and expands our competitive position and we will continue to deliver value to shareholders through dividend growth and share repurchases. Now, I'll turn the call over to the operator, and Ian and I will take your questions.

Thank you. Now we're going to take our first question, and the question comes from the line of Mike Harrison from Seaport Research Partners. Your line is open, please ask your question.

Hi, good morning.

Good morning, Mike.

Good morning, Mike.

Was hoping for maybe a little bit more color on the volume, I guess, cadence in the Performance Chemicals business. I guess in the fourth quarter, would volumes have been up, if not for the destocking impact? And I guess what are your thoughts on kind of the timing of further destocking, because it seems like based on your commentary for some additional volume pressure in the first half, like destocking is continuing. But I guess what we've been hearing from other people serving the Personal Care portion of the market that that's an unusual dynamic that was very pronounced at the end of Q4 and maybe should run its course a little bit sooner. And I guess beyond the destocking impact, can you just comment on what you're seeing in underlying markets or what you believe you're seeing in underlying markets within Performance Chemicals?

Yes Mike, it's Patrick. We experienced some delays in the destocking process. Many companies noticed this trend in the latter part of Q3, but we observed significant destocking during the last part of Q4, which is still ongoing. I believe most of the destocking will likely conclude during the first quarter. We've noticed some volume decline accompanying this trend. There is market instability in Europe and signs of a potential recession in the U.S. We're hearing from various sources about some volume loss, but we aren’t overly worried. I believe that as we navigate through these first two quarters, our diversified portfolio will be beneficial. The expansion efforts we initiated will start to take effect in the second half of 2023, leading to an increase in volumes. We're quite optimistic. While we manage the destocking and volume decline, we will focus on improving our manufacturing sites and cost structures to prepare for the upcoming increase in volume. Sometimes, slowing down a bit allows us to address issues while experiencing rapid growth, and that's what we're currently doing.

All right. And within the Fuel Specialties business, maybe just a little bit more color on what's been going on with gross margins there. And it sounds like you're still expecting to be below that 32% to 35% target range in Q1. But how should that progress during the year if everything goes according to plan?

Yes. I'll take that one, Mike. This is Ian. So, in Fuel Specialties, we've continued to see inflation in raw materials and also inflation from energy surcharges and labor increases. And as you're aware, in fuels that we always have that lag in a number of our pricing mechanisms. So, we're always a little bit behind the curve on the way up. And we're still taking price action in Field Specialties, and we'll continue to do that. For the remainder of 2023, we're expecting Fuel Specialties margins to remain at the lower end of the range. We'll take price action where it's required. Specifically, EMEA is a focus for us, and we're on top of that right now. China reopening will help us because that will bring in some higher-margin jet fuel. But it's really that basic blocking and tackling in Fuel Specialists that we need to carry out. And our view is that by the time we've got through that, inflation normalizes and we work through the high-cost inventory, we should return to the lower end of the range by the middle of the year and hopefully start to move through that range through the second half of the year.

Perfect. And then on the Oilfield business, you had initially thought that the Q3 strength would kind of normalize or roll off in Q4. So, what changed to lead Q4 to be even stronger than Q3? And maybe just help us understand why some of this additional business, presumably some new customer wins as well, might not be sustainable going forward?

Yes Mike, it's Patrick. We picked up some new accounts based off some technologies that we introduced to the market. And some of it is onshore, some of it is offshore. And so, a lot of it was the initial fields. So, you will see a little bit pullback in Q1. I wouldn't say a lot, but we still think, if you look at it year-over-year, that we will beat 2022 in Oilfield. It's a great technology that we presented. It's in the production side of the business, and we've improved marginally in our other business as well, and that's why we're still very confident that moving forward, even after these initial fills that we should still beat 2020 numbers.

All right. And then maybe just kind of putting all of this together, I was hoping that maybe you could provide some thoughts on what the full year could look like in terms of earnings growth, and I guess in particular, should Q1 operating profit be higher than Q4 or lower or kind of flat?

Yes Mike, this is Ian. I'll briefly go over each of the businesses. First, our largest business, Fuel Specialties, is expected to remain stable. We generated approximately $120 million in operating income in 2022 and we believe we can achieve a similar number in 2023 despite the recessionary challenges. Regarding Oilfield, we anticipate a slight improvement compared to 2022 and are hopeful for some additional growth, though we will have more clarity as the year progresses. The uncertainty lies in how quickly we will bounce back in Performance Chemicals. Currently, we expect a weak first quarter, some recovery in the second quarter, and stronger performance in the third and fourth quarters, returning to 2022 levels. Overall, this suggests that the first half of the year, especially Q1, will likely be weaker than the same period last year. I believe earnings may be slightly down mainly due to Performance Chemicals, but we are optimistic about growth in our Fuel Specialties and Oilfield sectors. This diversification in our portfolio is advantageous. If Performance Chemicals recovers faster, we might be able to match the $6 EPS we achieved in 2022, but at this moment, we're advising caution regarding that expectation.

Excellent. Thank you very much.

Welcome Mike.

Thanks Mike.

Thank you. Now we're going to take our next question, and the next question comes from the line of Jon Tanwanteng from CJS Securities. Your line is open, please ask your question.

Good morning. This is Stefanos Crist calling in for John. Thanks for taking our question.

Good morning Stefanos.

First, can you just break down the tax impact in Q4? Maybe how much was just itemized versus geography? And should we expect anything unusual going forward?

Yes, Q4 was a little bit unusual. What we've seen is that a number of our overseas entities have non U.S. functional currency books, and we saw a real strengthening of the dollar, particularly against sterling. That caused us to have some local gains, which is taxable in local books, but we back those out at Group. So, it just forced up the effective tax rate for the quarter. And that was the primary reason our effective tax rate was so high in the fourth quarter along with some geographical distribution of profits and one or two other smaller items. As we look into 2023, Stefanos, we are under pressure from our tax rates in the United Kingdom. They are increasing. And some of our other geographical distribution of profits will be a little bit higher. So, in the prepared comments, you heard me say that we expect the effective tax rate to be 28% for 2023.

That's great. Thank you. And then, can you just talk a little bit more about your large Oilfield customers, particularly in Q3 and Q4? It seems like they surprised to the upside. Do you have any color on what their plans are going forward?

Yes. It's interesting, it's not just in the U.S. We have the Saudi expansion. Some of it is over in South America. So, it's pretty broad in regards to geographical areas. And again, as I said in my earlier commentary, is that some of it was first fill. And then on a continuing basis, we'll just have to monitor to see if Q1 and Q2 can match Q3, Q4 of last year. We pulled back a little bit on the commentary just due to the fact that there were such large quarters but we still feel very confident in the business as a whole that it will at least match 2022 and probably beat it.

Great. Thanks for taking our questions.

Thank you.

Thank you. Now we're going to take our next question and the question comes from the line of David Silver from CL King & Associates. Your line is open, please ask your question.

Hello. I'm sorry, was that me? My call cut out for about five seconds.

Yes, David, it's you.

Thank you for your patience. I wanted to discuss the Oilfield results in more detail, specifically not just focusing on the fourth quarter. Patrick, you mentioned that certain non-production chemical areas within your Oilfield services haven't really seen participation. It appears that from a domestic standpoint, major oil companies are changing their strategies to be more aggressive on production and exploration. Could you highlight one or two of those subsegments that you mentioned that haven't fully participated yet? Also, what might be causing them to refrain from joining in, potentially affecting quarterly results in the coming quarters?

Yes. So, David, what we were saying in the commentary is that the production chemical side had massive growth in Q3, Q4. We see a little bit of pullback because a lot of that was first filled. A lot of the other businesses like completion, stimulation, drilling and some of our geographical areas like Saudi are now starting to contribute a lot more than they have in 2022. Therefore, that gives us the, I guess, confidence to say that we will, probably in 2023 beat our 2022 numbers. So, we are starting to see the other business in the other regions starting to pick-up, which is what we anticipated. And we're very happy with the position we're sitting in right now.

And just to follow-up on that. I mean, thank you for the detail about the first fill regarding the production chemical side. But I mean, I think wooden completions and stimulation activities also kind of have a jump start when they join in and begin to participate to a general upturn there or is it qualitatively different there?

It's a bit different, but we need to be cautious in stating that the major and mid-major companies are starting to invest significantly more capital than they did in 2022. However, drilling activity has not increased much, and the rig count has remained relatively stable. Given the current oil prices and political climate, these companies are quite disciplined with their spending. As a result, we don't expect to see a significant drop in the rig count, at least in North America. We are observing some increased activity in other regions outside North America, which is beneficial for us, and I believe this trend will continue into 2023.

Okay, great. I'd like to maybe ask a couple of financial-oriented questions. First on capital spend. So, I had penciled in a higher CapEx number and the total for this year came in about $20 million less. I'm assuming that's pretty much all related to the Performance Chemicals expansion activity. Could you just maybe just summarize, is this simply the case of some 2022 CapEx being deferred into 2023 or are there some other elements to that going on?

No, you're pretty much spot on there, David. This is Ian. Yes, we've got some rollover from 2022 going into the early parts of 2023. That's just a timing thing. We've got additional capacity coming on in the first half of the year. Now, we'll be a little bit more cautious perhaps beyond that and we may well slow things down. But our intention as we sit here right now is that the business will come back really strong. We're going to need that additional capacity. We're going to need that additional volume and we are expecting by the middle of the year to fundamentally have completed our original $70 million program in Performance Chemicals. So, you've just really got a little bit of delay, a little bit of timing delay, but fundamentally, our programs and our thoughts are unchanged.

Great. Thank you for that. And then maybe just one other question regarding working capital. So, by my measures, I mean, there was a release of working capital in the fourth quarter. But I think for the full year, I think this is still a year of a pretty sizable build-up in use, net use overall over the course of the year in working capital. And I think that follows on to a use of working capital in 2021 as well. Can you just talk about the current level of working capital regarding kind of run rate for that? Is this something that should continue to be maybe a meaningful source of funds in 2023? So, just the current level of working capital in regards to your business planning for 2023? Thank you.

Yes, So Ian, again, David. So, one of the things we've been talking about throughout the year is that we took a very conscious decision to hold high levels of inventory and raw materials so that we could keep customers supplied and that was across all three of our businesses. And we did that, and that was part of the reason we were so successful across the patch. We did see somewhat of an unwinding in Q4 as the Performance Chemicals business slowed a little bit. But certainly, Oilfield and Fuel Specialties kept going really nicely. We are, probably with inflation in the system, probably at the higher end of that working capital. But we do expect a small increase in working capital as we increase the volumes in Performance Chemicals towards the end of 2023 and as we continue to steadily grow both Fuel Specialties and Oilfields. So, you will not see as big an expansion, a bigger use of cash in working capital in the next 12 months, but you will see a little bit. But with a strong EBITDA and a lower level of expansion in working capital, we fully expect our cash flow to be quite nicely above where we were this year.

Thank you for that information. I have one last question for Patrick regarding the M&A outlook. Has your perspective on the project pipeline or valuations changed significantly in recent quarters? Is the current environment one of heightened uncertainty, and does that lead to better valuations from your viewpoint? How confident are you about pursuing a particular deal in this environment compared to a year ago? Thank you.

Thanks, Dave. I don't believe our strategic approach has significantly changed. I'm an opportunist, and in a high-interest-rate environment, the market tends to slow down. At some point, companies with leveraged balance sheets may face negative consequences. We are starting to observe a decline in valuations and more attractive deals entering the market. We remain very active and I'm not deterred from making purchases with our balance sheet, even in a challenging market, as long as the deal is right. In fact, that's often when we can achieve excellent results. We hope to identify several opportunities this year, whether they are smaller acquisitions or something more transformative. We are examining all options carefully and maintaining discipline in our purchasing approach. We are committed to managing our balance sheet wisely and our intention, David, is to keep increasing the dividend and take advantage of share buybacks when possible, while also preventing dilution. We are actively participating in the market and plan to continue doing so, with the hope of announcing a deal to our shareholders at some point.

Great. I appreciate all the color. Thank you.

Thanks David.

Thank you. And the next question comes from Christopher Shaw from Monness, Crespi, Hardt. Your line is open, please ask your questions.

Yes, hi. Good morning, guys. How are you doing?

Good morning, Chris.

Good morning, Chris.

You guys covered most of everything. But I am just going to ask, given the warm winter, both in North America and Europe, is there going to be an air pocket in Fuel Specialties in the first quarter from cold flow products or was it bad last year as well?

No, it was about the same as last year. And I think that we had a decent fourth quarter there. We'll have a decent first quarter as well. It hasn't really affected us one way or the other.

Got it. And you know I just thought of something just a second, but is the move to sustainable aviation fuel, does that impact the AvTel business at all or does it still require...

We're still quite far from that happening, Chris. We monitor everything closely and participate in discussions. It's going to be some time before AvTel is phased out.

Got it. All right, thanks a lot.

Thanks, Chris.

Thanks, Chris.

Thank you. There are no further questions. I would now like to hand the conference over to our speaker, Patrick Williams for closing remarks.

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 first quarter of 2023 results in May. Have a great day.

That does conclude our conference for today. Thank you for participating. You may now all disconnect. Have a nice day.