Earnings Call Transcript - IOSP Q2 2023

Operator, Operator

Good day, and thank you for standing by. Welcome to the Innospec's Second Quarter 2023 Earnings Release and Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I’d now like to hand the conference over to the speaker today, David Jones. Please go ahead.

David Jones, General Counsel and Chief Compliance Officer

Thank you. Welcome to Innospec's second quarter earnings call. This is David Jones, and I'm Innospec's General Counsel and Chief Compliance Officer. The earnings release for the quarter 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 8-K, 10-Qs and other filings with the SEC. Please see the SEC's site and Innospec's site for these and related documents. In our discussions 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 prior 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 of 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.

Patrick Williams, President and Chief Executive Officer

Thank you, David, and welcome, everyone to Innospec's second quarter 2023 conference call. Overall, this was another good quarter for Innospec. Excellent results in Oilfield Services continued to offset weaker activity in Performance Chemicals. In Field Specialties, we have taken a further charge to exit our trading relationship in Brazil, where inventory was misappropriated in the first quarter. Excluding this $8 million charge, which reduced our EPS by $0.21, our sales and EBITDA grew, and gross margins improved over the prior year. As expected, Performance Chemicals was again impacted by customer destocking and high cost inventory, which drove volumes, margins and mix lower in the quarter. While these headwinds will likely carry into the second half of the year, we expect our new Personal Care contracts to drive sequential sales, operating income and margin improvement. Our priorities remain focused on executing sequential sales and margin improvement in order to return to our operating income run rate to 2022 levels. In Fuel Specialties, continued price action and slowing inflation partially offset lower volumes in the quarter. As noted in our earnings release, adjusting for the $8 million Brazil charge, gross margins were unchanged versus the same quarter last year and remain in our target range of 32% to 35%. We do not expect any further charges related to Brazil and we expect gross margins to remain in this range for the balance of 2023. In terms of operating margins, our target continues to be 19% to 21%. We remain focused on growing sales, while maintaining margins as a key focus and opportunity for the Global Fuel Specialties team. Oilfield Services had another very impressive quarter. Continued strong activity in production chemicals, combined with further sequential improvement in our other oilfield segments drove significant organic growth. Operating income was over 6 times the prior year and gross margin expanded by 9.9 percentage points. In the quarter, we anticipate that sequential operating income will moderate on lower production chemicals activity, but we remain on track for significant full year growth in 2023. We continue to pursue top line and margin expansion opportunities across all our Oilfield segments. 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, Ian and I will take your questions.

Ian Cleminson, Executive Vice President and Chief Financial Officer

Thanks, Patrick. Turning to Slide 7 in the presentation. The company's total revenues for the second quarter were $480.4 million, a 3% increase from $467.6 million a year ago. Overall gross margin increased by 1.4 percentage points from last year to 31.3%. EBITDA for the quarter was $46.2 million compared to $52.9 million last year and net income for the quarter was $28.9 million compared to $32.3 million a year ago. Our GAAP earnings per share were $1.16, including special items, the net effect of which decreased our second quarter earnings by $0.12 per share. A year ago, we reported GAAP earnings per share of $1.29, which included a negative impact from special items of $0.29 per share. Excluding special items in both years, our adjusted EPS for the quarter was $1.28 compared to $1.58 a year ago. Our adjusted EPS of $1.28 includes the $8 million charge from exiting the Brazil trading relationship, which reduced our EPS by $0.21. We do not expect any further charges related to this matter and we continue to pursue both legal and insurance recoveries. Turning to Slide 8. Revenues in Performance Chemicals for second quarter were $127.8 million, down 24% from last year's $169 million, driven by a negative mix of 8% and a volume decline of 16%. Gross margins of 17.2% decreased by 8.6 percentage points compared to 25.8% in the same quarter in 2022, due to a weaker sales mix, higher cost inventory and adverse manufacturing variances resulting from lower production volumes. Operating income decreased 68% from last year to $9.2 million. Moving on to Slide 9. Revenues in Fuel Specialties for the second quarter were $154.2 million, down 13% from $176.4 million reported a year ago. A positive price/mix of 3%, partially offset a 16% reduction in volume. Fuel Specialties gross margins at 29.1% were 3.2 percentage points below the same quarter last year. Operating income of $17.1 million was down from $31.5 million a year ago. Adjusting for the $8 million Brazil charge, adjusted gross margins were unchanged versus the same quarter last year, and operating income was $25.1 million. Moving on to Slide 10. Revenues in Oilfield Services for the quarter were $198.4 million, up 62% from $122.2 million in the second quarter last year. Gross margins of 42.1% were up 9.9 percentage points on last year's 32.2%. Operating income of $28 million was a $23.5 million increase over the $4.5 million in the prior year. Turning to Slide 11. Corporate costs for the quarter were $20.1 million compared with $18.5 million a year ago, as lower share-based compensation accruals partially offset acquisition related and other costs. The effective tax rate for the quarter was 21% compared to 23.6% a year ago. The decrease in the effective rate was primarily because a lower proportion of the company's profits were generated in higher tax jurisdictions. Moving on to Slide 12. Free cash generation for the quarter was very strong with an operating cash inflow of $55 million before capital expenditures of $17.3 million. As of June 30, Innospec had $165.9 million in cash and cash equivalents and no debt. And now I'll turn it back over to Patrick for some final comments.

Patrick Williams, President and Chief Executive Officer

Thanks, Ian. This was another good overall quarter for Innospec. Throughout the first half of 2023, our balanced portfolio has performed very well in the face of significant end market headwinds. Adjusted for the Brazil charge, we delivered EBITDA growth and gross margin expansion over last year. As destocking runs its course and we return to normal customer order patterns, our business teams will stay focused on the key drivers of Innospec's long-term growth, namely best-in-class innovation and customer service. With excellent cash flow in the quarter and net cash of over $165 million, we continue to deliver on our record of returning value to shareholders, investing in organic growth and pursuing complementary M&A. This quarter, we continue to return value to shareholders with our $17.2 million semi-annual dividend and $0.6 million of share repurchases. In partnership with our customers, we remain well placed for long-term growth. Now I will turn the call over to the operator, Ian and I will take your questions.

Operator, Operator

Thank you. Now we are 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.

Michael Harrison, Analyst

Hi. Good morning.

Patrick Williams, President and Chief Executive Officer

Good morning, Mike.

Ian Cleminson, Executive Vice President and Chief Financial Officer

Good morning, Mike.

Michael Harrison, Analyst

Wanted to start with Performance Chemicals. Can you maybe talk in a little bit more detail about what you're seeing in terms of monthly volume trends, and I guess what are you hearing from customers in terms of the rate of destocking and when you might expect to see those order patterns start to normalize again?

Patrick Williams, President and Chief Executive Officer

Yeah, Mike. It's Patrick. No, we're starting to see order patterns pick up. We saw obviously a difficult Q1. Volumes were pretty stagnant in Q2. But towards the end of the quarter, we started to see the patterns pick up and we get a fairly good view about 30 days in advance. So in the third quarter, we're seeing volumes continue to go up, albeit at a slower pace than we'd hoped, but they are going up quarter-over-quarter. And we're cautiously optimistic that the destocking has been put behind us and that the markets are starting to normalize. So I would hope and suspect by Q4 and beginning Q1 next year that we will be back to somewhat normalized volumes and activity.

Michael Harrison, Analyst

All right. And you categorized in Performance Chemicals that 8% decline, we would normally see that listed as price/mix. You just called it mix, what was happening with pricing in the quarter on a year-over-year basis and can you give some more color on what drove your mix lower?

Ian Cleminson, Executive Vice President and Chief Financial Officer

Yeah, Mike. This is Ian. Yeah. We were really pleased with the ability of the business to hang on price. We've worked very hard and we're very mindful that with the sales mix is a little bit of the sort of higher end, higher margin businesses down year-over-year. But the business has been really disciplined in maintaining prices and that's not been easy against the high inflation backdrop and a lot of customers' preference. So yeah, a great job by the business there. And that's why we didn't call it out as price and mix. It was just mix this quarter.

Michael Harrison, Analyst

All right. And then just curious on the Fuel Specialties business and the volume decline you showed there. I know that some of those prior declines were related to some of the lower margin additives that you might just be reselling and you kind of exit that business or participate in that business on a more opportunistic basis. But it seems like this sequential step down that we've seen in revenue was a little bit bigger than what we might normally expect just due to seasonality. So I'm just curious, is there some destocking that you saw from your customers in that Fuel Specialties business, or maybe any other changes going on in underlying demand there?

Ian Cleminson, Executive Vice President and Chief Financial Officer

Yeah. I think we probably covered it that. We certainly saw some higher volume, lower margin business drop away year-over-year, very similar to what we saw in Q1 and we've not seen any destocking. And I think there's probably a little bit more seasonality in the Fuel Specialties business. For the last couple of years, it's been relatively flat as we have come out of the pandemic, but this year, as we come off the winter season, we do feel like Q2 and Q3 will be a little bit lower based on the seasonality of the business and we'll back in Q4.

Patrick Williams, President and Chief Executive Officer

Yeah, Mike. It wasn't a big concern when we looked at it because we did do a deep dive into that. I mean, as Ian said, there's some commodity products that dropped off like cetane. There was a lower AvTel quarter. So there was nothing really that concerned us. There was no loss of customers or any of that that you would immediately look at and ask the business. So I think overall, we're not concerned whatsoever with the volumes that we saw in the quarter.

Michael Harrison, Analyst

All right. Perfect. My last question is to get an idea of where you see earnings moving sequentially, excluding the $8 million impact from Brazil. It seems that Fuel Specialties will be similar or slightly improved, and Performance Chemicals should be better sequentially. I'm not sure about your expectations for Oilfield, which appears to have a sequential decline and might be somewhat softer. Overall, does Q3 look to be comparable to Q2 or should it be higher? Thank you.

Ian Cleminson, Executive Vice President and Chief Financial Officer

Sure, Mike. Let me address that and Patrick will follow up. Specifically, on a business-by-business basis, we anticipate that Performance Chemicals will show improvement in the third quarter compared to the previous quarter. We are seeing an increase in volume, which gives us more confidence. We started the quarter in a stronger position, and we expect operating income to be around $15 million to $20 million. For Fuel Specialties, we expect a quarter similar to the previous one, aiming for over $25 million in operating income, though I don’t expect it to exceed $30 million. Our current expectations for Oilfield are a bit more conservative. We have calibrated our forecasts for certain parts of that business. However, we are experiencing significant year-over-year growth in some other areas. We estimate operating income in the range of $15 million to $20 million for Oilfield, with the potential to increase if we receive some late-quarter orders. Combining all of this, Mike, I would project earnings per share to fall between $1.40 and $1.50, which is quite similar to what we achieved in the second quarter.

Michael Harrison, Analyst

Excellent. Thank you very much.

Ian Cleminson, Executive Vice President and Chief Financial Officer

Thanks, Mike.

Operator, Operator

Thank you. Now we are going to take our next question. And the next question comes from the line of David Silver from CL King & Associates. Your line is open. Please ask your question.

David Silver, Analyst

Good morning. Thank you for taking my questions. I joined the call a few minutes late, so I appreciate your understanding. First, I want to discuss the Oilfield Services segment, which has seen record revenues and operating income this quarter, making it the third consecutive record quarter. Initially, there was some mention from Ian or Patrick about initial sales benefits when the pickup began. However, the consistent strength and particularly strong performance this quarter raises questions. Is this growth due to gaining market share, the introduction of new products, or a result of reduced competition? Could you elaborate on what has contributed to the significant growth over the last three quarters, especially this most recent one? Also, what are your thoughts on the sustainability of this growth moving forward, particularly beyond the third quarter? Thank you.

Patrick Williams, President and Chief Executive Officer

It's a combination of factors. We're seeing gains in market share, continued progress with pricing, and this is happening globally across various areas. The team has effectively focused on margin expansion, pricing, technology, and gaining market share. This mix has contributed to another strong second quarter. As Ian mentioned earlier, the third quarter is still uncertain. It started off strong, and while we expected some moderation, there could be larger orders later in the quarter that might result in another robust quarter. However, we anticipate some moderation eventually, though we're not sure when that will happen—possibly this quarter or it could stretch into the fourth quarter. Overall, I believe the team has managed the business very well, and we just need to continue pushing forward along this path.

David Silver, Analyst

And if I could just follow-up. I'd love for you to comment or expand on the last sentence in one of the paragraphs in discussing Oilfield, but you said we plan to continue pursuing top line and margin expansion opportunities across all Oilfield segments. So I'm interpreting that as maybe a mix of inorganic and organic opportunities. But maybe if you could just expand on what that comment might pertain to?

Ian Cleminson, Executive Vice President and Chief Financial Officer

Yeah. Let me take that one, David. I think that's really about the discipline in the business about making sure that when we're growing and that we're getting profitable growth. We've been disciplined on pricing, disciplined on gross margins. As Patrick said here, the business has done a terrific job not just over the last quarter, but over the last number of quarters, and we've come out of the pandemic in a really strong way. They've really focused down hard on what's important to the business and the customer. We've delivered great technology, we're delivering great service and we're delivering great results, and we couldn't be more pleased with it. So it's just about keeping that discipline and focus on pricing, discipline and focus on customers and we've got full confidence in the team to go out and execute that.

Patrick Williams, President and Chief Executive Officer

And David, it's Patrick again. Just to add to Ian's comments. We have a project accelerated across all of our businesses and all of our manufacturing sites. And that's looking at where we can get cost savings. It's looking at where we can raise prices, it's looking at we can change technologies to provide the customer with a better technology at a less expensive cost. So we're looking at everything we can internally to make sure that, a, we're staying competitive; and b, we're taking out as much cost out of the system that we can. And that's across all business units and all businesses in general.

David Silver, Analyst

Got it. Thank you. I'd like to switch over to Performance Chemicals just quickly. And I'd like to pick up on the aspect where you were able to gain new Personal Care contracts beginning in the third quarter, kind of at the same time that there's a pretty substantial destocking element going on. So I was wondering, if you could maybe characterize where the new contract opportunities are coming from? In other words, are your existing customers seeking access to some of your newer products while they continue to work down inventories at some of your legacy SKUs or is this interest from completely new customers? Just how might we think about within a pretty tough overall environment the nature or how you would characterize your ability to gain some new contracts such that you anticipate sequential improvement even within a pretty difficult day-to-day environment? Thank you.

Ian Cleminson, Executive Vice President and Chief Financial Officer

Sure, David. Many of those contracts were actually finalized last year, which is why we incurred a $70 million expense for manufacturing expansion. This isn't something we are closing this year; we are carrying it into the third and fourth quarters. These closures were necessary for us to build or expand the plant to meet the volume requirements of our customers. A significant portion of this relates to reformulating for the natural beauty segment, focusing on reducing 1,4-dioxane and other toxins in the products to make them milder and more natural. This trend in the market has not slowed down, although you may have noticed some destocking. Therefore, we anticipate improvements in the third quarter and fourth quarter. We are confident that as the market begins to normalize and new contracts come into effect, we should experience substantial growth in this business moving forward.

David Silver, Analyst

Okay. I have one more question that's more about the overall picture. I'd like to start by discussing your recent financing agreement, which includes a base capacity of $250 million and the option to add $125 million more. Given that your company has maintained an excellent balance sheet for several years, could you explain why you chose this specific timing, size, and the features of this financing package? Is this funding meant to support ongoing organic growth in areas like Oilfield and potentially in Performance Chemicals, or is it simply a matter of having more options available? Considering you have a substantial amount of cash on the balance sheet and a track record of avoiding debt, could you share your thoughts on the rationale behind the size, nature, and timing of this updated financing facility? Thank you.

Patrick Williams, President and Chief Executive Officer

David, I'm going to let Ian talk about the refinancing and I'll address a little bit of the M&A activity and the use of capital.

Ian Cleminson, Executive Vice President and Chief Financial Officer

Yeah. So David, the refinancing, it's really a rollover of our previous facilities. It's the same in terms of quantum. They were probably due about a year out that was lapsed. So we've renewed that with a slightly different banking group and with probably less covenants. So we're in good shape, I think there the dry power, as you call it, is there and available for the business just like it has been for last number of years. So yes, very supportive bank group, very supportive of the strategy, and we just want to go out and put it to good use.

Patrick Williams, President and Chief Executive Officer

Yeah. David, it's Patrick. And just to add to Ian's comments. We're not ashamed of having a pristine balance sheet. And you've seen some of the information that we've put out that we are looking at M&A activity. We are looking at some deals. We hope to have something done by end of Q3, early Q4. It won't be a large deal, so it's not necessarily going to affect the balance sheet much. So our key is let's focus on organic growth as the markets normalize, obviously, we'll have to put more capital back to work. In addition, we've increased the dividend, which we plan to continue to do so. We've done a little bit of buybacks in the market, and the plan is to have some dry powder for some more M&A as we move forward. And I think as you know, we're very responsible in where we deploy cash, and we will remain that way moving forward. So again, we're proud of our balance sheet. We're not going to stress it, and we're going to move forward in a very responsible, conservative way.

David Silver, Analyst

Thank you very much. I appreciate all the color.

Patrick Williams, President and Chief Executive Officer

Thank you.

Ian Cleminson, Executive Vice President and Chief Financial Officer

You’re welcome.

Operator, Operator

Thank you. Dear speakers, there are no further questions at this time. I would now like to hand over to yourself for any closing remarks.

Patrick Williams, President and Chief Executive Officer

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 third quarter 2023 results in November. Have a great day, everyone.

Operator, Operator

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