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Edited Transcript of IOSP earnings conference call or presentation 7-Nov-18 2:00pm GMT

Q3 2018 Innospec Inc Earnings Call

LITTLETON Nov 15, 2018 (Thomson StreetEvents) -- Edited Transcript of Innospec Inc earnings conference call or presentation Wednesday, November 7, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David B. Jones

Innospec Inc. - VP, General Counsel, Chief Compliance Officer & Corporate Secretary

* Ian P. Cleminson

Innospec Inc. - Executive VP & CFO

* Patrick S. Williams

Innospec Inc. - President, CEO & Director

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Conference Call Participants

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* Curtis Alan Siegmeyer

KeyBanc Capital Markets Inc., Research Division - Associate

* Jonathan E. Tanwanteng

CJS Securities, Inc. - MD

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Presentation

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Operator [1]

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Good day, and welcome to the Innospec's Third Quarter 2018 Earnings Release and Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to David Jones, General Counsel and Chief Compliance Officer. Please go ahead.

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David B. Jones, Innospec Inc. - VP, General Counsel, Chief Compliance Officer & Corporate Secretary [2]

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Thanks for joining our Third Quarter 2018 Financial Results Conference Call. As you know, late yesterday, we reported our financial results for the quarter ended September 30, 2018. The press release is posted on the company's website, www.innospecinc.com. 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 6 months.

Before we start, I would like to remind everyone 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 have also included some non-GAAP financial measures. The 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.

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Patrick S. Williams, Innospec Inc. - President, CEO & Director [3]

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Thank you, David, and welcome, everyone, to Innospec's Third Quarter 2018 Conference Call. Innospec's third quarter performance has demonstrated what we've been saying for some time. Our strategic portfolio is strong and with good underlying growth and with continued opportunities to improve profitability and cash generation. I am delighted with the improvements of all 3 of our strategic businesses. And although, there are more improvements to come, the key metrics are all moving strongly in the right direction. Just as importantly, we returned solid cash generation during the quarter, with the reduction in net debt on an already healthy balance sheet.

Fuel Specialties delivered good volume growth and just as significantly, improved margins, which are back towards top end of our expected range. This filtered down into a 15% growth in operating income. After several quarters of exceptional sales growth, Performance Chemicals had a steady quarter and still grew by revenue by 4%. Again, the attention we've been paying to gross margins provided further improvement to profitability, which helped drive operating income up by 28%.

Oilfield Services, once again, grew at a faster rate than the market as the value of our technology and service is recognized by an ever-increasing number of customers. Gross margin, while not if yet improving on prior year, has turned the corner with a sequential implement of 2 percentage points. The impact is a fourfold increase in operating income compared to the same quarter last year.

Octane Additives delivered to expectations, and there is a possibility of one further similar-size order this year, with delivery either in the fourth quarter or early in the first quarter 2019.

Looking into next year, we have limited visibility but expect this business to finally end with one further order in the first half of 2019.

While our major focus remained sales growth and margin improvements, we are constantly looking to improve the effectiveness of our operations. This led us to conclude that some of our European operations should be focused on our centers of excellence, particularly where this involves the critical functions of R&D and customer technical service.

As previously announced, we will be making a significant investment in all our centers in Ellesmere Port, U.K. and the Castiglione, Italy. We will therefore be exiting the facility at our Everberg, Belgium, which was part of the acquisition we made at the end of 2016.

We have taken part of the charge for this in Q3 2018 results, and the remaining smaller charge will be taken in the second half of 2019 as the project concludes.

We have taken great confidence from this quarter's performance. And I'm very pleased to report that the board has approved a further increase in our dividend, which brings the total payment for 2018 to $0.89 per share, which is a 15% increase over 2017.

The board has gone further than simply increasing the dividend. As an additional measure to return value to shareholders, they have sanctioned a new share purchase program, which will

(technical difficulty)

up to $100 million of stock over the next 3 years.

Our portfolio has delivered an excellent quarter, and we believe there are further improvements to come. Now I will turn the call over to Ian Cleminson, who'll review our results in more detail. Then I will return with some further comments on the quarter and our outlook. After that, we will take your questions. Ian?

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Ian P. Cleminson, Innospec Inc. - Executive VP & CFO [4]

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Thanks, Patrick. Turning to Slide 7 of the presentation. The company's total revenues for the third quarter were $363.1 million, a 9% increase from $332.4 million a year ago. The overall gross margin was 30.6%, up from 29.7% last year, driven by improved margins in both Fuel Specialties and Performance Chemicals. Adjusted EBITDA for the quarter of $44.7 million was just ahead of last year, but included a restructuring charge of $4.8 million related to our European operations and the associated exit from the Everberg site in Belgium. Our GAAP earnings per share $0.84 included several special items, the net effect of which decreased our third quarter earnings by $0.36 per share. A year ago, we reported GAAP earnings per share of $0.95, which included a negative impact from special items of $0.05 per share. Excluding special items in both years, our adjusted EPS for the quarter was $1.20 per share compared to $1 reported in the third quarter of 2017, a 20% improvement.

Moving on to Slide 8, revenues in Fuel Specialties for the third quarter were $134.9 million, 4% higher than the $130.1 million reported a year ago. This was driven by a 3% improvements in volumes and a 1% favorable price and mix impact.

Revenues were particularly strong in the Americas, up 16% on prior year. In Asia-Pacific, revenues were broadly flat, within EMEA slip by 2%.

Gross margins were up both compared to last year and sequentially. We delivered margins at the higher end of our range at 36.2%, up 1.9 percentage points on the same period last year with margin improvements in all the regions.

Operating income was up for the quarter at $28.8 million, a 15% improvement on last year.

Turning to Slide 9. Revenues in performance chemicals were up by 4% on a strong quarter last year, rising to $114.8 million. This was driven by volume growth of 3% and a positive price mix impact of 1%. Gross margins were 22%, up 3.2 percentage points on the same quarter last year and up 2 percentage points sequentially. Operating income was up 28% from last year from at $12.4 million.

Turning to Slide 10, in Oilfield Services, revenues of $104.2 million were up 27% from the third quarter of 2017, driven by further improvements in customer activity, especially in stimulation.

Overall volumes were up by 24%, and there was a positive price mix impact of 3%.

Revenues were up almost 10% sequentially.

Gross margins improvement sequentially by 2 percentage points to 32.1%. Compared to the same quarter last year, gross margins declined 2.7 percentage points as we continue to experience a strong inflationary environment.

Operating income was $7 million in the quarter, up almost 4x from the same period last year as we leverage higher revenues from a similar cost base.

Moving on to Slide 11, revenues in Octane Additives were $9.2 million compared to $10.1 million in the same quarter a year ago, with the latest order being fulfilled as expected.

Gross margin was down at 37% reflecting lower production volumes and higher cost inventory. Operating income was $2.7 million for the quarter compared to $4.4 million in the same period last year.

As Patrick stated, we expect to receive an order for around $8 million in Q4 2018, with delivery added in the fourth quarter or in the first quarter of 2019.

Beyond that, we have indications that there may be one further order in the first half of 2019.

Turning to Slide 12. Corporate costs for the quarter were $12.7 million, up $0.7 million from the same period last year but within our expected range. The effective tax rate for the quarter was 32.2% compared to 22.1% last year, driven by the geographical location of taxable profits. We expect the full year effective tax rate to be 27%.

Moving on to Slide 13. We closed the quarter with net debt of $136.8 million compared to $162.2 million at the end of last quarter.

As anticipated, our cash generation has improved. Our leverage moved lower, ending the quarter with net debt approximately 0.7x adjusted EBITDA.

Net cash from operating activities in the quarter was $34.8 million. As of September 30, 2018, Innospec had $91.4 million in cash and cash equivalents and total debt of $228.2 million. And now, I'll turn it back over to Patrick for some final comments.

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Patrick S. Williams, Innospec Inc. - President, CEO & Director [5]

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Thanks, Ian. We have often delivered good results in quarters where not all businesses were firing on all cylinders. This quarter, we had all 3 of our strategic businesses showing improvement sequentially and most metrics improving over prior year.

Even with a reduction in Octane Additives, we have delivered a 32% improvement in operating income before restructuring charges and a 20% increase in adjusted EPS.

All of our businesses have undertaken further new product launches to meet customer needs, and we feel confident that these will help underpin future growth. We are excited by a number of organic growth projects, which are in the pipeline, although we have tied up cash in the short term.

Cash conversion has improved in the third quarter, and our net debt has consequently reduced to around 0.7x adjusted EBITDA. With our strong balance sheet and cash flow, we will continue to participate in acquisition activities, which will add shareholder value, but we will maintain our disciplined approach while multiples remain high.

We continue to invest in our R&D and customer technical service in a number of our strategic of facilities, including Salisbury, North Carolina; Houston, Texas; Ellesmere Port, U.K.; and Castiglione, Italy.

The combination of our excellent results, strategic investment programs, improved dividend and a new share purchase -- repurchase program gives us great confidence as we head towards the end of the year and into 2019. Now I'll turn the call over to the operator, and Ian and I will take any of your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Curt Siegmeyer from KeyBanc Capital Markets.

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Curtis Alan Siegmeyer, KeyBanc Capital Markets Inc., Research Division - Associate [2]

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Just one on the margin improvement you guys saw on -- in Fuel Specialties and Performance Chemicals and then, obviously, the Oilfield business still trying to catch up. Just wondering if you could talk about some of the different dynamics you're seeing in each of those segments in terms of costs related to either raw materials as well as freight. And should we expect, as we move forward, maybe pricing to be able to help offset some of the margin contraction that you pointed out in the Oilfield business?

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Patrick S. Williams, Innospec Inc. - President, CEO & Director [3]

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Yes, you're starting to see margins heading in the right direction, which is what we expect. And I think we alluded to that in the Q1 and Q2. And for us, you're exactly right, it's part of pricing that's going to help us get there. There's inflationary measures all over all 3 of our businesses. And one of the things that you have and it's just around the whole chemical industry is how you extract those cost differentials and cost increases and how you get the value of those moving forward. And I think for our team, it's extra customer service, it's passing on the increases where we can, and it's obviously new products. I think we've done a very good job of balancing that. Therefore, you've seen margin improvements in Performance Chemicals, you've seen margin improvements in Fuel Specialties. And you're definitely starting to see more volume to the same asset base in the Oilfield services sector, which obviously, dropped our or brought our net operating income up 4x what it was. So I think all the things that we discussed in Q2 have come about in Q3. And we, kind of, gave everybody that indication that, that was going to happen in Q2, and it's exactly what happened.

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Curtis Alan Siegmeyer, KeyBanc Capital Markets Inc., Research Division - Associate [4]

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Great. And then if I could, on a follow-up. As you think about 2019 and some of the opportunities going into next year, I was wondering if you could update us just on your DRA investment as well as anything new on the MRO 2020 (sic) [IMO 2020] and GDI front?

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Patrick S. Williams, Innospec Inc. - President, CEO & Director [5]

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Sure. You have GDI just coming into market, it's an unknown. We think we have a very good technology. It remains to be seen as to when and how fast they will match that technology over the next 2 to 3 years. And I think for us, it's just going to take market maturity. And we'll get some sales in 2019. I'm not sure it's going to be a large amount, but it should be a nice start to '19. DRA, the plant is up and running. We've run our first trials in the plant. We will now be taking them out to field trials, and so we should see some revenue boost in 2019, the latter part of it. The first part of '19 will be trials and getting it ready for commercial use. And then, on IMO 2020, we all know the regs, and as long as the IMO 2020 just keeps those regs, it should benefit us come into latter part of '19, latter part of '20 as well. So the pipeline is full because those aren't the only 3 products that we have within our organic pipeline, and I think you guys will see the benefit of that in '19 and '20 and '21. We've really set ourselves up well from a technology standpoint for the next 3 years.

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Curtis Alan Siegmeyer, KeyBanc Capital Markets Inc., Research Division - Associate [6]

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Great. And then just on the tax rate, we should be thinking about for '19, is that 22% that you mentioned for '18, a good starting point for now?

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Ian P. Cleminson, Innospec Inc. - Executive VP & CFO [7]

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Yes, we think we're going to do 27% effective tax rate for 2018. And we think 27% for 2019 is a good number as well.

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Operator [8]

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Our next question today comes from Jon Tanwanteng from CJS Securities.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [9]

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Can you give us an update on the ultimate or the long-term margin potential in each of the businesses? You've been talking about a lot of new products both in Fuel and Performance Chemicals. What are the targets then, given incremental margins on new products and existing ones in a more normalized input environment?

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Ian P. Cleminson, Innospec Inc. - Executive VP & CFO [10]

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Sure Jon, let me take that one first. So just running through the businesses pretty quickly. Fuel Specialties, as you know, that's a business that operates in a range of gross margins depending on the cycle. So we would be expecting gross margins to be in that sort of 33% to 35% range, with operating margins in 19% to 21% range. Very -- pretty much situation where we are today. Our Performance Chemicals business is perhaps the one area where we do expect to see some improvement in margins. We've done a great job in the last 2 years, and we're probably a little bit -- probably, at least, a little a year, maybe 2 years ahead of our strategic plan there. So we've been seeing pretty rapid gross margin expansion. And we think in the next year, we could probably out another percentage point both to the gross margins and also down to the operating margins. And our operating margin level, we certainly expect a 10% to 11% performance there from Performance Chemicals. In terms of Oilfield, that's slightly difficult, depending on where we are in the oil cycle. We certainly expect to add at least 1 more percentage point on to our gross margins and see that drop down to our operating margins. But certainly, over the midterm, we would expect to be heading towards double-digit operating margins in Oilfield as well. But that is going to take a little bit of time.

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Patrick S. Williams, Innospec Inc. - President, CEO & Director [11]

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Yes. I think, it, just to add on what Ian has said, is one of the things that we discussed again in the last 2 quarters was the goal is to get all of our operating margins into double digits. And you can see that we've inched that way up in Q3 with Performance Chemicals. You can see that we've drastically changed the operating margins, it's been up 2 percentage points over the previous quarter and operating income as well. And then, obviously, Fuel Specialties has gotten back into that -- the range -- the high-end range that we were anticipating. So our belief, I think, with the new products coming on board, we'll know a more effect of what they will do on the margin cycle, more towards the latter part of '19. But what Ian's given you is exactly right for the first half of 2019. And they will address the other product portfolio as they come into play.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [12]

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Got it. That's very helpful. And just on the Additives business, the IMO 2020 regulations has been getting a lot of play in the media. We've been seeing a lot of talk about scrubbers and -- versus actually getting better or new fields, which will benefit you. Do you have any idea where that balance is going to play out? How many ships are going to upgrade and how many ships are going to actually purchase something with your Additives?

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Patrick S. Williams, Innospec Inc. - President, CEO & Director [13]

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Yes, I'm not sure anybody really knows, quite frankly. We even talked to refineries, they have no idea how they're going to make all that fuel as well and what they're going to do with the residuals. I think for us, there's only so much scrubbing technology in the market place. They could only put so much on ships. A lot of the new ships are having scrubbers put on, but there's no doubt the opportunity is going to be with fuel additives, even with scrubbers, you're going to have additives you have to use as well. So there's opportunities. We don't know the magnitude. We know it's going to be a pretty big increase for us, and that is a higher-margin product. But until we really see what the refineries are going to do, are they going to put -- are the -- are all the ships going to go to some form of a scrubber, which -- that cannot happen, but you will see some scrubbers on some of these. But it's really what they're going to burn, what fuel they're going to burn and how they're going to do it. I think it's, kind of, late 2019 to get a better feel at exactly how it's going to go. Either way, we are set up very well for when that market turns into IMO 2020 on a regulation basis.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [14]

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Got it. And then finally, can you just rank your priorities and capital allocation here, new products potential M&A, dividends, buybacks? And just on the buyback, are you planning to just offset dilution or actually reduce your share count here?

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Patrick S. Williams, Innospec Inc. - President, CEO & Director [15]

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Yes, let me start. As we always said organic growth is your cheapest and most profitable growth. And we are going to focus on all of our new product technologies that we're growing organically, and I think that's the smartest growth we have. I think the other you've seen us increase our dividend. The likelihood is our dividend will be over a $1 next year. We've increased to 15% per year. We don't see a reason why we won't change that. We've got the cash flow to do that. We've got the cash flow for the acquisitions. We got the balance sheet to do it. Third, we're going to look at acquisitions that fit our portfolio. We're not going to chase multiples. Now we are starting to see some multiples come down and to more realistic levels. And I think we just have to sit tight and be patient. But on the stock buybacks, I think one of them is to prevent dilution but I think as well to be to be really creative in a market where the chemicals sector is down 32%. We're down 16% over the last 2 months where the chemical sector is down 32%. I think that at the right time, we'll be in and be very creative in using our repurchase program.

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Operator [16]

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As there are no further questions, I would like to hand back to Mr. Patrick Williams for any closing remarks.

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Patrick S. Williams, Innospec Inc. - President, CEO & Director [17]

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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 with you again for our fourth quarter results in February, 2019. Thanks again.

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Operator [18]

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Ladies and gentlemen, that will conclude today's conference call. Thank you for your participation today. You may now disconnect.