Innospec Inc.

there will be the question and answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automatic message advising your hand is raised. To withdraw your question, please press star 11 again. 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 released in 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 risk and uncertainties that can cause actual results to differ materially from the anticipated results implied by such forward-looking statements. The risk and uncertainties are detailed in InSPEC's 10-K, 10-Qs, and other filings with the SEC. Please see the SEC site and InSPEC 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're 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 Clementson, Executive Vice President and Chief Financial Officer. And with that, 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 oil field services and steady results in field 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 margins continue 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 remained 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 four-year operating income. Production chemicals continue to have a 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 cells will moderate. However, we expect further top line and margin improvement in our other oil field segments, and we remain very optimistic that we can deliver sequential four-year operating income growth in 2023. Now I'll turn the call over to Ian Clemson, 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?

Thanks, Patrick. Turning to slide seven 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 gap earnings per share were $1.02 including special items the net effect of which decreased our fourth quarter earnings by 18 cents a share. A year ago, we reported gap earnings per share of 96 cents, which included the negative impact from special items of 34 cents 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 36 cents 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 gap earnings per share were $5.32 including special items which decreased our full year earnings by $0.72 per share. In 2021, we reported gap 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 eight, revenues in performance chemicals for the fourth quarter were $143.9 million, up 4% from last year's $138.4 million. A positive price mix of 18% was offset by a 5% volume decline and adverse currency impact of 9%. Gross margins at 18.4% were down three percentage points from last year, impacted by lower production volumes due to customer destocking and high raw material costs, primarily in the US. 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've 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 nine, 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 Specialty's gross margins at 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 normalises. 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 was $16.5 million compared to $13.2 million a year ago, due mainly to high 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 36 cent 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 65 cents 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 31st, 2022, NSVIC 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 is 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 will we continue to deliver value to shareholders through dividend growth and share repurchases? Now I'll turn the call over to the operator, and he and I will take your questions.

Thank you. As a reminder, to ask a question, you need to press star 11 on your telephone and wait for a name to be announced. To withdraw your question, please press star 11 again. Mr. Bauer will compile the Q&A roll start.

This will take a few moments. Now we're going to take our first question.

And the question comes from the line of Mike Harrison from Seaports Research Partners. Your line is open. Please ask your question. Hi.

Good morning. Good morning, Mike. Good morning, Mike. I 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, you know, 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, you know, beyond the stocking 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?

Yeah, Mike, it's Patrick. You know, we were a little probably delayed in the destocking. You know, a lot of companies started to see it in the latter part of Q3. We saw a lot of destocking in the latter part of Q4. It's still there. I will say a lot of the destocking will probably be finished sometime in the first quarter. But what we have seen, and you've probably heard the same commentary, is that there's been a little volume destruction along with it. You've got a little bit of market disarray in Europe. You've got a little bubbling of the recession waters in the US. And we are starting to see, and we've heard from multiple people, some volume destruction. That does not concern us as much. I think that we'll get through these first two quarters, and having a diversified portfolio is going to help us. But I think the benefit to us is that that expansion that we put forth will take into effect in the latter part, the second half, I should say, of 2023. And you'll see volumes kick back up. So we feel pretty confident. I mean, I think that we're going to do some things behind the scene while we're seeing destocking and while we're seeing some volume destruction. You know, we're going to work on our manufacturing sites, our cost basis. multiple things to prepare ourselves for that second round of volume. So it's, you know, tapping the brakes sometimes gives you the ability to fix some things while you're in such fast growth. And I think that we're doing that as we speak.

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?

Yeah, 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 fuel 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 specials that we need to carry out. And our view is that by the time we've got through that, inflation normalises and we work through the higher cost inventory, we should return to the lower end of the range by the middle of the year and hopefully start to move up through that range through the second half of the year.

Perfect. And then on the oil field business, you know, 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.

Yeah, Mike, it's Patrick. We picked up some new accounts based off some technologies that we introduced to the market. And some of it's onshore, some of it's offshore. And so a lot of it was the initial fills. 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 oil field. 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 2022 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?

Yeah, Michael, let me take that one. This is Ian. I'll just sort of run through each of the businesses at a high level. First of all, our biggest business, Field Specialties, that's going to be a steady-eddy business for us. We delivered about £120 million of operating income in 2022, and we see no reason, even with the recessionary headwinds, why we shouldn't be able to match that number in 2023. We've covered off oil field previously. We expect that business to be slightly ahead of where we are, where we were in 2022. And we're confident that there may even be some upside to that business. But we'll know more about that as we move throughout the year. The unknown, I guess, is how quickly we'll recover in performance chemicals. Our view right now is that we're going to have a week Q1 will start to recover in Q2 and the quarters three and four will be much stronger and back to where we were in the 2022 levels. When you wrap all that together, Mike, that does mean that the first half of the year and particularly Q1 is going to be a little bit weaker than we saw in the first half of 2022. I think overall earnings will be slightly down, primarily because of the performance, chemicals performance, But we do remain confident that both our fuel specialties and oil field businesses are positioned for growth. It's the benefits of having that balanced portfolio. And if we can get the performance chemicals business recovering a little bit faster, we may be able to match our $6 of EPS that we did in 2022. But right now, we're just pegging people back a little bit against that number.

Excellent. Thank you very much. You're welcome, Mike. Thanks, Mike.

Thank you. Now we're going to take our next question. And the next question comes to the line of John Tangwantang from CJS Securities. Your line is open. Please ask your question.

Good morning. This is Stephanos Christ calling in for John. Thanks for taking our questions. 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?

Yeah, Q4 was a little bit unusual. What we've seen is that a number of our overseas entities have non-US 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 backed 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, Stephanos, we are under pressure from our tax rates in the United Kingdom. They're 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 the upside. Do you have any, you know, color on what their plans are going forward?

Yeah, you know, it's interesting. It's not just in the U.S. You know, we have the Saudi expansion. Some of it's over in South America. So it's pretty broad in regards to geographical areas. And again, as I said in my earlier commentaries, that some of it was first bill. And then on a continuing basis, we 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 they 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 Silva from CL King and Associates. Your line is open. Please ask the question.

Hello, I'm sorry. Was that me? I had my call blanked out for about five seconds.

Yes, it's you, David. Yes, David, it's you.

Okay, you can hear me. Okay, thank you. Sorry about that. Okay, so first I did want to just kind of delve into the oil field results just a little bit, and in particular not so much about the fourth quarter, but Patrick, you cited, you know, non-production chemicals aspects of, you know, within your oil field services that I'm paraphrasing, but I think you said that those product lines or those subsegments hadn't really participated. And it does seem like certainly from the domestic perspective, I mean, there's a change in plans at some of the major oil companies in terms of becoming more aggressive, I guess, on the production and EMP side. But what are those – if you could just highlight one or two of those other subsectors that you said hadn't really fully participated to date, and why wouldn't they join in and lead to some more robust quarterly results, maybe certainly over the next few quarters at least?

Yeah, 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 fill. 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, you know, regarding the production chemical side, but You know, I mean, I think wouldn't completions and stimulation activities also, you know, kind of have a jump start when they, you know, when they join in and begin to participate, you know, to a general upturn there? Or is it qualitatively different there?

It's a little different, but you're, you know, we've got to be cautious in saying that the majors and even mid-majors are coming back and putting a lot more CapEx in the ground that they originally did in 2022. Drilling has not gone up that much. So rig count has stayed fairly steady. I think in today's oil prices, in today's political environment, you're not going to see, they're pretty disciplined right now with their capital. And so we don't see a massive rig count trump in at least North America. We are seeing some increased activity in other areas outside North America, which is where we've benefited. And I think you'll continue to see that in 2023 as well.

Okay, great. I'd like to maybe ask a couple of financial-oriented questions, first on capital spend. So, you know, 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, you know, is this simply the case of, you know, some 2022 CapEx being deferred into 2023, or, you know, are there some other, you know, elements to that going on?

You're pretty much spot on there David, this is Ian. We've got some rollover from 2022 going into the early parts of 2023 so 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're 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, you know, 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, you know, pretty sizable buildup 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, you know, run rate for that? Is this something that should continue to be maybe a meaningful source of funds in 2023? So just, you know, the current level of working capital in regards to your business planning for 2023. Thank you.

Yes, 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 oil field 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 oil fields. 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 of working capital, we fully expect our cash flow to be quite nicely above where we were this year.

Okay. No, that's very helpful. Thank you. And then just last question for Patrick on the M&A outlook. Has anything – meaningfully shifted in your thinking about either, you know, your project funnel or the level of valuations over the last few quarters? You know, is this current environment a little more, one, characterized by elevated uncertainty, and maybe that translates into improved valuation, you know, from your perspective? Just to How comfortable are you maybe pulling the trigger in the current environment on a particular deal, maybe relative to a year or so ago? Thanks.

Yeah, thanks, Dave. I don't think it changes necessarily our strategic thinking. You know, I'm an opportunist. And with high interest rates, the LTO market's dried up. And so I do think at some point in time where you have companies who have leveraged balance sheets, there's going to be a negative effect there. And obviously there's a rollover into multiples. So we are starting to see some extraction on multiples. We are starting to see some, I would say, more interesting deals coming to the market. We are remaining very active. It's not going to scare me to buy with our balance sheet In a down market with high interest rates if I can get the right deal at the right multiple and that quite frankly that's when you do very very well and So the hope is that we'll find a few things this year whether they're tuck-ins Smaller ones or whether we do trans something transformational We don't know that yet, but we're we're looking at everything. We're very disciplined buyers and we will remain that way and We're very disciplined with our balance sheet. Our view, David, is to continue to increase the dividend and take advantage of share repurchases when we can, and more importantly, to prevent dilution. But we're actively in the market, and we'll continue to be active in the market. And we hope at some point in time we'll be able to announce a deal to our shareholders.

Great. I appreciate all the color. Thank you.

Thanks, David.

Thank you. Now we're going to take our next question. Please stand by.

And the next question comes to the line of Christopher Shaw from Moniz Crespi Hart. Your line is open. Please ask your question.

Yeah, hey, good morning, guys. How are you doing?

Good morning, Chris.

Good morning, Chris. You guys covered most everything, but I was just going to ask, Given the warm winter, both North America and Europe, is there going to be like an air pocket and 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. I thought of something just a second, but the move to sustainable aviation fuel, does that impact the Aptel business at all, or does it still require it?

We're a long way off from that happening, Chris. I mean, it's, you know, we watch everything that's going on. We sit on the panels. We're quite a ways off until Aptel goes away.

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 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.

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