Innospec Inc.

Good day and thank you for standing by. Welcome to the InnoSpecs second quarter 2023 earnings release and conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be the question and answer session. To ask a question during the session, you need to press star 11 on your telephone keypad. 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 speaker today, David Jones. Please go ahead.

Thank you. Welcome to NSFAC's second quarter earnings call. This is David Jones, and I'm NSFAC's general counsel and chief compliance officer. The earnings released for the quarter 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 It can cause actual results to differ materially from anticipated results implied by such forward-looking statements. The risk and uncertainties are detailed in InnoSpec TID-K, TIN-Qs, and other filings with the SEC. Please see the SEC site and InnoSpec 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 measure should not be considered as a substitute for or superior to those prepared in accordance with GAAP. They are included as additional items to aid investor understanding of the company's performance in addition to the impact that these items and events had on financial results. With me today from Innispec are Patrick Williams, President and Chief Executive Officer, and Ian Clementson, Executive Vice President and Chief Financial Officer. And with that, I turn it over to you, Patrick.

Thank you, David, and welcome everyone to Innispec's second quarter 2023 conference call. Overall, this was another good quarter for Innespec. Excellent results in all field services continue 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 21 cents, 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 mixed 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 improvements. 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 field 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 will remain focused on growing sales while maintaining margins as a key focus and opportunity for the global fuels specialties teams. 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 six times the prior year, and growth margins 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 oil field segments. Now I will 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 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 gap earnings per share were $1.16, including special items, the net effect of which decreased our second quarter earnings by 12 cents per share. A year ago, we reported gap earnings per share of $1.29, which included a negative impact from special items of 29 cents 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 eight, Revenues in performance chemicals for the 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 nine, revenues in fuel specialties for the second quarter were 154.2 million, down 13% from the 176.4 million reported a year ago. A positive price mix of 3% partially offset a 16% reduction in volume. Fuel Specialty's gross margins of 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 to 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. Leavenews and 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 30th, Interspec 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. Thanks Ian.

This was another good overall quarter for Interspec. Throughout the first half of 2023, our balanced portfolio has performed very well in the face of significant in-market headwinds. Adjusting 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, and he and I will take your questions.

Thank you. Dear participants, as a reminder, if you wish to ask a question, please press star 1 1 on your telephone keypad and wait for your name to be announced. To withdraw your question, please press star 1 1 again. 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 Seaport Research Partners. Your line is open. Please ask your question.

Hi, good morning.

Morning, Mike. Good morning, Mike.

I 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 today? 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?

Yeah, Mike, it's Patrick. You know, 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 of 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 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 of Q1 next year, that will lead back to somewhat normalized volumes and activity.

All right. And you categorized in performance chemicals that 8% decline. We would normally see that listed as price mix. You just called it mixed. 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?

Yeah, Mike, this is Ian. Yeah, we were really pleased with the ability of the business to hang on to price. We've worked very hard. We're very mindful that the sales mix is a little bit off, the sort of higher-end, higher-margin business is down year-over-year. But the business has been really disciplined in maintaining prices, and that's not been easy against that high inflation backdrop and a lot of customer pressure. So, yeah, 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.

All right. And then just curious on the fuel specialty of 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?

Yeah, I think you've probably covered it, Mike. You know, we certainly saw some higher volume, lower margin business drop away year over year, very similar to what we saw in Q1. And, you know, we've not seen any destocking. And I think there's probably a little bit more seasonality in the fuel specialties business. The last couple of years, it's been relatively flat as we've come out of the pandemic. But this year, as we've come off the winter season, we do feel that Q2 and Q3 will be a little bit lower based on the seasonality of the business. And we're back in Q4.

Yeah, Mike, it wasn't a big concern when we looked at it because we did do a deep dive into that. And as Ian said, there's some commodity products that dropped off, like CTAIN. There was a lower Aptel quarter. So there was nothing really that concerned us. There's 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.

All right, perfect. And then my last question is maybe just to get a sense of kind of sequentially, where do you see earnings going? And let's adjust out the $8 million Brazil impact. But net-net, it sounds like the expectation would be that fuel specialties would be similar to maybe a performance chemicals better sequentially. And then I don't know what your expectation is for oil field sequential decline, but it sounds like that is going to be a little bit softer sequentially. So net-net, does Q3 look pretty similar to Q2 or should it be higher? Thank you.

Yeah, Mike, let me kick off on that one and Patrick will come over the top. So, taking it business by business, yeah, we expect performance chemicals to be improved in Q3 sequentially. Our comments are saying that we're getting more volume through, we feel a little bit more confident and we've started the quarter in better shape. Our expectations there are that we'll probably be somewhere around 15 to 20 million of operating income In fuel specialties, again, I think a very similar quarter to what we've had this time around. We'll be in that 25 million plus range. I don't think it'll go above 30 million of operating income. Well, that's our expectations right now. Oil field is a little bit more difficult. We've tempered the expectations in parts of that business. We're still seeing tremendous year-over-year growth in some of our other businesses, but we do think that'll be more in that sort of 15 to 20 million range in terms of operating income. Now, that could go higher depending on some orders that might come later in the quarter, but our best guess now is around that 15 to 20 million operating income range. When you package all that up together, Mike, I would expect EPS to be broadly somewhere between 140 and 150 as we sit here right now, which is very similar to to where we are in that quarter two.

Excellent. Thank you very much.

Thanks, Mike.

Thank you.

Now we're going to take our next question. And the next question comes from the line of David Silver from CL King and Associates. Your line is open. Please ask your question.

Yeah, hi, good morning. Thank you. I'm going to apologize in advance. I had to join the call just a few minutes late. But I do have several questions. So firstly, just if you wouldn't mind, in the oil field services, I mean, this was a record quarter, both revenues and operating income. And I would just say it's probably the third record quarter in a row. So initially when there was this pickup, I guess there was a thought that I think, you know, Ian or Patrick may have commented that there was some initial fill benefits and things like that. But, you know, the continued strength and especially kind of the outsized performance of this quarter is this just share gains with your new products? Or, you know, if you were to say what's different with this, you know, substantial pickup, you know, maybe if you could just comment on, you know, whether you think it's cyclical, whether it's sustainable, is it the new products, is it the exit of some competition? Just if you could kind of characterize, you know, what's led to the considerable strength, let's say, the last three quarters, and especially this one, and, you know, your comments on the sustainability of it, let's say, beyond, you know, your comments on the third quarter. Thank you. Yeah, David, it's Patrick.

You know, it's a little bit of everything. It's share gain. It's continued progress with pricing. And it's global. It's not just one specific area. I think the guys have done a really good job across all of the businesses within oil field specialties to really look at margin expansion, pricing, technology, and share gains. And it's really been a little bit of all. And where we saw initial fills, we picked up more business. And so that enabled us to have another strong second quarter. And I think, as Ian alluded to in the last comments he just made, Third quarter kind of remains to be seen. It started out strong. We thought it would moderate. We could get some bigger orders toward the latter part of the quarter that can make it another very strong quarter. But there will be some moderation at some point in time. We just don't know when. We think it's going to be this quarter, but it could be the fourth quarter. But I think overall, I would say the guys have done a really, and gals have done a really good job of managing this business. And we just got to keep pushing forward and continue on the path that we're on.

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 oil fields. But you said we plan to continue pursuing top line and margin expansion opportunities across all oil field 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.

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 that we're getting results. profitable growth. We've been disciplined on pricing. We've disciplined on gross margins. As Patrick said, you know, the business has done a terrific job, not just over the last quarter, but over the last number of quarters. And they'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. They've delivered great technology. They've delivered great service. And they're delivering great results. And we couldn't be more pleased with them. 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.

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 where 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.

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 of 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, you know, your ability to gain some new contracts such that, you know, you anticipate sequential improvement, you know, even within a pretty difficult day-to-day environment. Thank you.

Sure, Dave. A lot of those contracts were actually last year, and hence why we had the $70 million spin on manufacturing expansions. In addition, so this is not something that we've necessarily closed this year, and we're carrying forward in the third and fourth quarter. These were last year's closures that we had to actually build the plant or expand the plant to hit the volume requirements that these customers are looking for. And a lot of it is a reformulation to the natural beauty side of the business. You know, 1,4-Dioxane, less toxins in the product, more mild, more natural. That's where the market's been heading. That has not stopped. You might have seen a slowdown or some restocking, but a lot of this is what's going on, hence why we think that the third quarter will improve and the fourth quarter should improve as well. So we're confident that as the market starts to normalize and the new contracts that start to take effect, that we should see some nice growth in this business moving forward.

Okay, and then maybe one last one, kind of a bigger picture question. But I would like to maybe use as a starting point, you know, your recent new financing credit facility or financing agreement. So, you know, $250 million base capacity plus the opportunity to add $125 million additional I'm looking at that in the context of a company that's had an absolutely pristine balance sheet for a few years now. Maybe if you could talk about why the timing and the size and the features of that financing package made sense for you here. In other words, is this the dry powder you need to do, you know, wave round after round of organic growth maybe in oil field in addition to, you know, the next round maybe on performance chemicals? Or, you know, is this just pure optionality? I mean, you know, so for a company with, you know, a fair amount of cash on the balance sheet and a history of not holding on to any debt, Maybe you could give us your thinking on the size and the nature and the timing of that redo of your financing credit facility. Thank you.

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.

Yes, the refinancing is really a rollover of our previous facilities. It's the same in terms of quantum. They were probably due probably about a year out. They were lapsed. So we've renewed that with a slightly different banking group and with probably less covenants. So we're in good shape and it's there. The dry powder, as you call it, is there and available for the business just like it has been for the last number of years. So, yeah, very supportive bank group. very supportive of the strategy, and we just want to go out and put it to good use. 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'd 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. You know, so our cue is let's focus on organic growth. And as the markets normalize, obviously we'll have to be putting more capital back to work. In addition, you know, 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 powders 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.

Thank you very much. I appreciate all the color.

Thank you. You're welcome.

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.

Thank you all for joining us today, and thanks to all our shareholders, customers, and Inspec employees for your interest and support. If you have any further questions about Inspec 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.

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