Innospec Inc (IOSP) 2017 Q1 法說會逐字稿

Good day, and welcome to the Q1 2017 Innospec Inc. Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to David Williams, General Counsel. Please go ahead, sir.

Thank you, and good day, everyone. My name is David Williams, and I'm Vice President and General Counsel and Chief Compliance Officer at Innospec. Thanks for joining our first quarter 2017 financial results conference call. Today's call is being recorded.

As you know, late yesterday, we reported our financial results for the quarter ended March 31, 2017. The press release is posted on the company's website, www.innospecinc.com. An audio webcast of the call and the slide presentation on the results are also now available and will be archived on the website.

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 discussions 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 and in the presentation that follows, 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.

With that, I'll turn it over to you, Patrick.

Thank you, David, and welcome, everyone, to Innospec's first quarter 2017 conference call.

I'm delighted to be able to report that we had a really good start to the year. During our last call, I indicated that we built up momentum in the second half of last year and that we were optimistic about 2017. Our optimism was completely justified, and we have delivered ahead of expectations. With sales up 39% and adjusted EBITDA up 20%, we have delivered adjusted EPS of $1 per share, which is 8% ahead of the same quarter last year. This is despite the movement of over $13 million of Octane Additives sales into the second quarter.

Oilfield Services entered a tough year in 2016, although the trends in the second half of the year were moving in positive direction. I'm pleased to tell you that those trends have continued into 2017 as we expected.

Sales were up substantially, both sequentially and against the same quarter last year, and we have held margins stable while controlling cost. This has resulted in a significant turnaround in operating income from a loss of $5.5 million in the comparable quarter to a profit of $3 million this quarter. In Fuel Specialties, we are pleased to see the return of volume growth, especially in the Americas, although that steady growth has been accompanied by the expected normalization margins that we had previously indicated.

This business continues to be a key component of our portfolio, with solid growth prospects and excellent cash generation. It has been a very busy quarter for Performance Chemicals, as we have made significant process -- progress integrating the business that we acquired from Huntsman at the end of last year. The acquisition had performed according to our strategic plan. It was accretive from day 1 and has delivered an additional $0.10 of adjusted EPS after financing cost, which is exactly as we indicated when we first announced the deal back in August 2016.

The heritage Innospec business has also performed well, with further new product launches adding to the combined portfolio. Customer reaction to the acquisition has been positive, and the overall business is now on a very solid platform for long-term global sustainable growth. Turning to Octane Additives, we received a further order from the one remaining customer for approximately $20 million. However, the timing of the order meant that we were only able to ship an invoice $6.9 million in the first quarter compared to $17.8 million in the same quarter last year. The balance of the $13 million will be delivered in Q2.

In summary, this has been a strong quarter with all our core businesses delivering at or above expectations, giving us a further optimism for the rest of 2017. Now I'll 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 first quarter contributed $294.3 million, a 39% increase from $212.1 million a year ago. Excluding the acquisition, like-for-like sales were up 11% year-over-year. The overall gross margin decreased by 5 percentage points from last year to 30.9%, driven by the addition of the lower-margin acquired business in Performance Chemicals and the lower contribution from Octane Additives.

Adjusted EBITDA for the quarter was $39.2 million, a 20% increase compared to last year. Our GAAP earnings per share was $0.70, including special items, the net effect of which decreased our first quarter earnings by $0.30 per share. A year ago, we reported GAAP earnings per share of $0.77, which included a negative impact from special items of $0.16 per share.

Excluding special items in both years, our adjusted EPS for the quarter was $1, an 8% increase from $0.93 a year ago.

Moving on to Slide 8. Revenues in Fuel Specialties for the first quarter were $126.4 million, a 3% increase from $123.4 million reported a year ago. Volumes were up 8%, partially offset by an adverse price in product mix of 5% and a 1% negative currency impact.

The business continued to make steady progress in Asia Pacific, while there was a pleasing return to volume growth in the Americas. The quarter was a little softer in EMEA, primarily due to order phasing rather than any change in demand. Fuel Specialties gross margin for the quarter was still strong at 36.5%, up 2.5 percentage points from the same quarter last year, [but] down sequentially as we have anticipated.

Operating income for these segments were $26.8 million, up 12% from $23.9 million in the first quarter of 2016.

Turning to Slide 9. Sales in Performance Chemicals for the first quarter were $94.5 million compared to $34.7 million last year. While much of this increase is attributable to the acquisition from Huntsman at the end of 2016, the heritage Innospec business also grew by 3%, as volume growth of 3% and a favorable price mix of 1% offset an adverse currency impact of 1%.

Gross margins of 17.7% were adversely impacted in the quarter by a $1.7 million one-off fair value inventory adjustment to the acquisition. On an adjusted basis, gross margins were 19.5%, broadly in line with the 20% expected for the combined business. Operating income for the quarter was $6 million, up 36% on the $4.4 million in the comparative quarter and include the negative impact of the $1.7 million one-off fair value adjustments.

Moving on to Slide 10. As Patrick indicated earlier, and as we expected, our Oilfield Services business continued its recovery with the full successive quarter of improved sales and profits. Sales of $66.5 million were 84% up on the same quarter last year, with increased customer activity the main driver. Volume growth of 115% was offset by a price mix reduction of 31% with lower selling prices driven by lower raw material costs compared to the same quarter last year. However, raw materials have increased slightly on the fourth quarter of 2016. Gross margins of 38.2% were up 6.2 percentage points on the comparable quarter, but steady on a sequential basis.

Operating income was $3 million compared to a loss of $5.5 million for the first quarter of 2016. Moving on to Slide 11. Net sales in Octane Additives for the quarter was $6.9 million, down from a $17.8 million in last year's first quarter, as over $13 million of the current $20 million order slipped into the second quarter. The segment's gross margin was 39.1%, and operating income for the quarter was $2 million compared to $11 million a year ago.

After we complete the current order in the second quarter, we have no further confirmed orders on hand. However, there are indications that our customer will require additional products in the second half of the year. We will continue to update you on each quarterly call. Turning to Slide 12. Corporate cost for the quarter were $10.7 million compared to $10.2 million a year ago. This is within our expected range.

The effective tax rate for the quarter was 25.9% compared to 22.9% last year, reflecting the geographical mix of the business, and we expect the full year effective tax rate to be approximately 25%.

Moving on to Slide 13. When we announced the acquisition from Huntsman, we indicated that we would not be acquiring either accounts payable or accounts receivable, and that we would to inject approximately $25 million of working capital into the business. This outflow in the first quarter was $28.6 million and contributed to a net operating cash outflow across the group of $19.9 million for the quarter before capital expenditures of $6.7 million.

We expect to return to cash generation in the second quarter as working capital position stabilizes. As of March 31, Innospec have $45.4 million in cash and cash equivalents, and total debt of $243.7 million, resulting in net debt of $198.3 million.

And now I'll turn it back over to Patrick for some final comments.

Thanks, Ian. The strong performance of all of our strategic businesses in the first quarter further confirms that our strategy is well balanced and right on track. We are very positive about our prospects for the future, and we are very well placed to deliver solid growth from all of our core businesses.

As we indicated in our last call, our Oilfield Services business has benefited from the industry recovery and continues to grow profitably. Fuel Specialties is again delivering steady growth, and even with margins normalizing, our cash generation is excellent. Prospects for this business are solid in all regions.

We are delighted that our new acquisition Performance Chemicals has made a good start with the exact earnings that we expected in the quarter. The combined portfolio of products will be among the best in the industry, launched from our global platform and aligned with customers in all regions.

I'm very pleased to announce that the board of Innospec has sanctioned a further increase in our semiannual dividend. Over the past 3 years, we have increased our dividend every 6 months, with an annualized increase of 10% in every year. We have decided to accelerate this increase and have approved a semiannual dividend payment of $0.38 per share, which will be payable later this month.

This is in line with our target to improve the dividend for the full year by 15%, further returning value to the shareholders. We will continue to complete the task of integrating our new acquisition over the coming months, with the enlarged Performance Chemicals business well placed to make a good contribution to our global platform and balanced portfolio.

We remain receptive to further acquisition opportunities, which could enhance our portfolio with a focus on adding to our technology or our geographical coverage. Now I will turn the call over to the operator and Ian and I will take your questions.

(Operator Instructions) We shall take our first question from Jonathan Tanwanteng from CJS securities.

Participant seem to have removed himself from the queue.

So we shall now take our next question from Curtis Siegmeyer from KeyBanc Capital Markets.

Just the top line growth was pretty impressive, excluding the Huntsman acquisition, up double digits in the quarter. But seems like that would be a pretty tough achievement to maintain that over the course of the year. So maybe if you could help us -- how should we think about top line potential as we move forward throughout the year and comps potentially get a little bit more difficult as well?

Yes, Curt. I think it's obvious that we probably grew above market expectations. And I think if you break down the market sectors that we're in and still if you look at Performance Chemicals, including the Huntsman acquisition, we fully realize it's going to take a full year through remainder of this year to fully integrate it, and then obviously, get the output of that moving into 2018 and the benefits of it. If you look at Oilfield and the basins that we're located in and the drilling activity and the completion activity in those basins, we fully expect double-digit increases throughout the year. We'll, obviously, every quarter update as we see crude [oil] prices fluctuate, but we feel very confident that we'll get double-digit growth continued throughout 2017 in the Oilfield sector. If you look at Fuel Specialties, it was finally back to that GDP plus 2% to 3% as we've been stressing for quite some time. There is a little low in EMEA, but that was just order pattern. I think it's same with Asia Pacific. EMEA had kind of a warm winter, so it hurt on the heating oil side and the cold flow side. But overall, there's nothing there that does not tell us that demand is still intact. So we're feeling fairly confident. In 2017, it will sustain nice growth rates.

Okay. Great. And then one on Oilfield Services. You've been able to turn the profit now for a couple of quarters in a row there. Are we at a price level with oil where it is now and given some of the volatility where we can expect that business to kind of remain profitable for the year? Is there maybe a rule of thumb where if oil drops below $40, you guys get a little nervous in terms of the activity that you see there?

Yes. Good question. As we alluded to in the last couple of quarters, I think the U.S. has adapted extremely well to low oil prices. I think it's kind of backfired to OPEC quite frankly. So we've adjusted our pricing. I think technology has really brought the cost down into a [cost narrow] we feel like in the markets that we're in. It's probably the lowest cost basins globally. We don't have social cost we have to deal with, et cetera. Technology has really changed the game here. I think from a price of our view, obviously, there could be views all over the place, but our view is about anywhere from that $45 to $55, $60 range will still grow. I think if you start getting under $40 a barrel, obviously, people start pulling back. But being that we've gone through a round of layoffs a couple of years ago when oil prices went down below $40, we've learned to adapt, and I think that we've controlled our growth. You've obviously seen our SAR cost. We have controlled that inside the Oilfield sector. So I think we are adaptable either way. We just got to be ready for when prices creep up into the high $50s and more activity kicks up. I think that's really what we're focusing on right now.

We shall take our next question from Jonathan Tanwanteng from CJS Securities.

Can you hear me? I think there was an issue with my line.

Yes, we can hear you, Jon.

Okay, great. I'm sorry, if this is already asked, but Fuel Specialties margins were once again above where you were hinting at exiting last quarter. Just can you talk about the components of that? And what drove it? And how sustainable you think it might be?

Yes, I think, John, we -- as we -- we basically said in the last couple of quarters that margins were extremely strong, stronger than we expected, and that we would get some raw material movement that would push those [down into] more normalized margins. We used to, historically, be in that 32% to 33% range. Now we're saying 34% to 35%. We're about 36.5%, I believe, for the quarter. But I would suspect, John, that 35% for modeling purposes is probably a good model moving forward in 2017 through remainder of the year, unless you get a real spike in crude prices.

Okay, great. That's helpful. And then just in the Oilfields business, rig counts keep increasing. What have you been seeing on the ground, in terms of volumes versus your ability to price?

What was the last portion of your question, John, I'm sorry?

The volumes you're selling versus your pricing ability?

Well, I mean, if you look at it, it's majority volume growth, obviously. You've seen on the top line revenue and you've seen that in the inflection point, where we are now starting to drop to the bottom line. We've outgrown rig count. And I think if you recall the last few quarterly calls we talked about is, oil and rig count was an anomaly at some point in time. I think we're almost starting to get back to some normalization in the marketplace, where falling rig count gives you a better view of what the overall market is going to look like. But our view moving forward is that we feel very confident in double-digit growth where prices sit right now. We typically get, as we stated in the past, that we'll get a 3- to 4-month ahead due of what that quarter is going to look like in Oilfield just due to the fact that the CapEx programs that we're involved in. So we're fairly confident that similar numbers that you see in Q1 will be similar numbers you see in Q2.

Got it. And then just on the Huntsman business. You saw a run rate of $0.10 cents of accretion, I guess, in the first quarter that you had it under the Innospec umbrella. Do you see that growing significantly going forward? Because that would put you, I guess, above the target that you set last year when you said you'd see about $0.40 of accretion?

Yes, I think probably keeping it at $0.10 per quarter is probably the right thing to do. I -- my true feeling on this is, it's going to take us literally through 2017 to fully integrate. And I don't think you'll start seeing full marketing and sales benefits, revenue benefits and even GP benefits until early 2018. I mean, you know as a acquisition this size, for a company of our size, it takes significant work behind the scenes to get this fully integrated. This acquisition came with some really strong personnel. We're very happy. It's exactly what we expected. But I really don't see the true growth that we're expecting until 2018. But the acquisition is truly what we expected from an EPS standpoint in 2017.

Got it. And then just finally, any commentary on avgas? How it's performing in the quarter? And how you see that developing through the year? And if you see a potential replacement for that on the horizon at all?

Yes, it was pretty much normalized in the quarter. There wasn't a spike, up or down. With avgas, it won't be a replacement of that. It will be a complete fuel replacement. And it's still in the queue. At some point in time, it will happen. I don't think it's going to happen anytime in the near future.

(Operator Instructions) We shall take our next question from Chris Shaw from Monness, Crespi.

We might want to move to the new question. Chris, we can't hear Chris.

Your line is open Mr. Dezellem from Tieton Capital Management.

I actually have a group of questions here, if I may. First of all, relative to Oilfield, you've talked about the success that you're having there. Is there a point that the incremental profitability accelerates, and essentially incremental margins grow at a more rapid rate than they have? Or do you see it just more continuing on as is?

Bill, from the onset, because the growth has been so drastic, obviously, when you get growth, you have to put capital back into it, whether it's SAR cost or if it's capital requirements. So I think with the massive growth that we've seen in the quarter, in the 2 previous quarters, you won't get that inflection point quite yet. I think once you get some stabilization in the market and we don't see the growth that we're seeing as fast as we're seeing, you'll start seeing that hit the bottom line a lot quicker, but it will build over time. And at some point in time, you'll start seeing it reflect back into a more operating income.

So interestingly the inflection point is being held back by the success and so as -- when we hit that point that the rate of growth slows, and I won't say that you can catch your breath, but there's just less investment required to keep up, then that's when we should anticipate that real inflection point?

Yes.

Great. And then relative to the Octane business, has your customer made any progress over the course of the last year that you are aware of, building out their refinery capabilities? And I asked the question really in a grander question, which is, how should orders look this year versus last year in total?

Yes. I mean, the limited information that we get, Bill, they have not made a lot of progress, which is pretty much as we anticipated. We would probably say, we'll have another order as we've indicated in our script at the latter part of 2016. And the likelihood is, we'll have some orders going in 2017.

So net of it is that their consumption, putting your orders aside for a moment, their consumption this year should be similar to last year is simply because they have not made forward progress, and how the order pattern shakes out is as you just described?

That is correct.

And then R&D has ticked up -- consistently been ticking up. Would you talk a little bit about what's going on behind the scenes that you're brewing up in your R&D labs?

Sure. I mean, it's -- if you look at the growth it doesn't come because we don't have technology backing it. So most of the growth that you see in all of our businesses is because of introduction new technologies to the marketplaces. So you have seen a little uptick in R&D. And I think as you see the growth patterns that if we stay on those growth patterns, I think you'll see a little bit more uptick. But at some point, it levels out as well. So I think it's pretty minimalized on an R&D uptick. But you could see the output that it has provided in the quarter.

And actually I would like, if I may, to come back to Octane for just a moment. What's the lead time that it is going to take your customer to make the changes they need ultimately to no longer require the MTB? Just trying to understand how much visibility that you get. I mean, is it 6 months, is it 2 years? How does that end up working?

Yes. The problem, Bill, is you just don't know. As we always say, refineries don't go unleaded, countries go unleaded. And we believe that 2 of the 3 refineries are capable of going unleaded today, but the largest refinery is not obviously capable of going unleaded. So I would say you get as much information as you get, you might get 3 to 6 months max to kind of figure out if they're going to be ordering anymore or not. That's why we continuously update you guys every quarter, because we get as much information as we can out there. But we'll continue to update you every quarter, because we just don't know.

Okay. And then finally, you referenced in your release, in your commentary this morning, that you are open to acquisitions and partnerships. And given how the company is organized today and the businesses that you have, would you talk a little bit in more detail about your strategy for acquisitions and partnerships from this point going forward?

Yes, I mean, one of the things that we pride ourselves on is that we put out a strategy 5 years ago and we stuck to that strategy. We wanted a balanced portfolio of our 3 businesses, and we've done that we this acquisition with Huntsman. So not only did it give us a balanced global portfolio for Performance Chemicals, but it balanced out our corporate portfolio. And that's really what we want to do, to take some of this cyclicality out of the market. I think for us moving forward now, we're at about 1.4x levered, that will probably come down to 1.1x, 1.2x. So we have a great balance sheet to do more if we want to. Right now, we're in full integration mode. That's going extremely well. I think if you look at things that we might do in 2017, it would be a small geographic acquisition or a technology acquisition. I'm not sure you'll see anything major in 2017. I think we need to bite off this Huntsman acquisition first. But if you look at the strategy now and you look at the portfolio, you'll see that we'll start biting off on, as I said earlier, acquisitions in technology or geographic expansion. And that expansion doesn't have to be an acquisition. I mean, your cheapest capital is your organic capital. And so if we could build it, internally, we'll build it internally. If we can find a JV partner, where we have control and interest, we'll look at that as well. So it's not that we have to go out and purchase, we like to be traded in another ways.

(Operator Instructions) We shall take our next question from Chris Shaw from Monness, Crespi.

Yes, let's try this again. Can you guys hear me?

Yes, no problem, Chris.

I wanted to expand on -- I mean, John was asking about the Fuel Specialties margins giving the indication of where you expect it to be. But what is causing this strength? Is it that you guys are getting pricing? Has the raw material inflation really not hit yet? Is it just mix? Is there lot of AvTel in there? Could you give a little color there?

No, it's not the bonus of AvTel. It is product mix. We've been able to hold margins with raw materials coming off a little bit, but we are starting to see some increases of raw materials. That's why we came off a extremely high margin in Q4. And as we said in that call, we would start seeing that normalizing. It came up a couple of points in Q1. So I think it's a combination of a lot, Chris. I think you will see, for modeling purposes, we are telling everybody that you might even see a little more pullback throughout the year. But I'd again say it's probably -- it will be above our historic, so 35% probably more of a solid number.

Okay. And then on the Performance Chemicals, on the accretion from Huntsman. I'm just curious how you get to the $0.10. I just -- I can't seem to figure it out, because the operating income obviously is not up that much in the segment year-over-year and then there is the interest expense. But is there just something -- there are some add-backs and stuff that I just don't -- I haven't seen or I can't figure out on my own?

Yes, Chris, this is Ian. Yes, you need to add back the amortization for the acquisition on the fair value accounting adjustment that we talked about in the script. So you got an adjustment back of about $0.14 on the business and then you got a $0.04 financing cost as well to take you down to $0.10. So there's a couple of adjusted actions in there.

We shall take our final question from Sean Milligan of Coker & Palmer.

On the Oilfield Service side, if you get double-digit growth throughout this year, what kind of EBIT margins do you anticipate being able to achieve this year?

Yes, Sean, this is Ian. So in the first quarter, we had about 11% EBITDA margins and round about -- probably about 5% operating income margin. So as Patrick was saying earlier on, as we start to see more operational leverage going through the business, we see higher revenue growth and we can contain that cost base and we can hold our margins. There's no reason why we can't seem to exit this year probably roundabout mid-teens on EBITDA margins and probably heading towards double digits on operating income margins. Well, that's very much dependent upon what happens to the activity levels in the market and where oil price goes.

Okay. Great. All right. And then if we look at the fuel segment, if you look at 2015 and 2016, in terms of top line, both those years were down. And then this year, for the first quarter, at least you are up year-over-year on a top line basis. So my question was, were some of the negative trends that we were seeing in terms of top line on a year-over-year basis in both '15 and '16 alleviating? And is this going to be a year of kind of flat to upgrowth for the fuel business from a top line perspective?

Yes, I think some of the trends -- if you look at the expectations, the economy expectations, have gone away. I think if you also look at, which is more importantly, customer patterns have continued in the direction we anticipated as well as we picked up new business. And I think that, that's obviously added to the positive trend. New technology obviously helps us with new business. I would suspect, in 2017, you'll see a flat to a GDP plus 2% to 3% growth right in that ballpark.

Okay. And then the same type of question. In terms of the legacy Performance Chemicals business, on a year-over-year basis, you [replied] that you grew at 3%. I was just curious about what type of growth rate for the legacy business you thought you could achieve this year? I think previously you had made comments about sort of high single digits were the potential growth rate. But I just want to make sure if it's still the case based on what you are seeing?

Yes, it's still the case. I'd say mid- to high-single digits is still a fair number.

All right. And one last question, if I'm rounding off the call. On the G&A line, I was surprised and I know it's up year-over-year, but adding Huntsman, all things considered, you were able to keep that in check pretty good. What kind of G&A creep do you think we see through this year on higher volumes in Oilfield and that kind of stuff? What's the -- if I'm looking at my model, what do you think the right kind of exit rate G&A has to use on a quarterly basis?

Yes, that's a tough one to answer on Oilfield, Sean, depending on where the business goes. If we continue to see revenue growth like we have in Q1, we added about $5 million to the SG&A line in quarter 1. So if we keep seeing revenue growth like that going through, I think we'll certainly see an increase in G&A in Q2 as the business continues to perform. I think it might flatten out in the back half of the year, depending where we get to. I think the Huntsman business, as we said, that's added $4 million to $5 million at the quarter-end. That should be pretty steady for the full year. And the rest of the business will just be an inflationary growth, so 2% to 3% increase year-over-year. So depending on the moving parts in Oilfields, it really depends on where we get to. I think the Huntsman G&A is pretty much baked in now.

All right. And then one last quick question, if you look at the first quarter -- I know the tax rate is creeping up a little bit on you. What percentage of your business, in terms of like pretax income, is related to -- would be taxed at a higher U.S. corporate tax rate and potentially would be positively impacted if that were to be adjusted?

Probably 45%, in that area.

As there are no further questions in the queue, that will conclude today's Q&A session. I would now like to turn the call back to Mr. Patrick Williams for any additional or 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 Q2 2017 results in August. Have a great day.

That will conclude today's conference call. Thank you for your participation ladies and gentlemen. You may now disconnect.