Innospec Inc.

Welcome to Inispec's earnings call. This is David Jones. I'm Inispec'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 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 InnoSPEC's 10-K, 10-Qs, and other filings with the SEC. Please see the SEC site and InnoSPEC site for these and related documents. We've also included non-GAAP financial measures, a reconciliation to the most directly comparable GAAP financial measure 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 InnoSpec 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 InnoSpec's third quarter 2023 conference call. InnoSpec delivered another set of good results. We are well positioned for continued organic growth through innovation and customer partnerships across all our businesses. Performance Chemicals delivered strong sequential operating income growth along with margins expansion as new personal care contracts commenced and volumes from our existing business improved. While destocking remains a headwind, we believe that it has peaked. We are cautiously optimistic that we will achieve further sequential operating income growth and margin improvement in the coming quarters. In addition, we believe that our continued investments in technologies like our industry-leading 1,4-dioxide-free and sulfate-free chemistries are well aligned with ongoing consumer and regulatory trends. In fuel specialties, operating income was broadly similar to last year as approved margins offset lower sales volumes. These results were below our internal targets, but we expect sequential margin improvement and operating income growth with our chemistries into the winter quarters. Margin improvement remains a key median term focus and opportunity for our fuel specialties business. Oilfield Services had another strong quarter with double digit operating income growth and margin expansion over the prior year. As expected, activity levels moderated on a sequential basis, but remained on track for significant four-year improvement in 2023. In the fourth quarter, we anticipate similar results to this quarter as we continue to have a strong pipeline of opportunities across all our oil field segments and geographies. Now I will turn the call over to Ian Clemmonson, 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 third quarter were $464.1 million, a 10% decrease from $513 million a year ago. Overall, gross margin decreased slightly by 0.8 percentage points last year to 29.6%. EBITDA for the quarter was 56.5 million compared to 59.2 million last year and net income for the quarter was 39.2 million compared to 38.7 million a year ago. Our gap earnings per share were $1.57 including special items, the net effect of which decreased our third quarter earnings by 2 cents per share. A year ago we reported gap earnings per share of $1.55, which included a negative impact from special items of 19 cents per share. Excluding special items in both years, our adjusted EPS for the quarter was $1.59 compared to $1.74 a year ago. Turning to slide eight, revenues and performance chemicals for the third quarter were 145.2 million, down 9% from last year's £159.7 million, driven by a negative price mix of 19%, being partially offset by higher volumes of 7% and a positive currency impact of 3%. Gross margins of 20.9% decreased by 3.6 percentage points compared to 24.5% in the same quarter in 2022, due to a weaker sales mix and higher cost of inventory. Operating income decreased 33% from last year to £16.9 million. Moving on to slide 9, revenues in fuel specialties for the third quarter were £169.3 million, down 5% from the £178.7 million reported a year ago. Volume reductions of 4% and a negative price mix of 4% were partially offset by a positive currency impact of 3%. Fuel Specialty's gross margins of 31.3% were 1.4 percentage points above the same quarter last year due to a richer sales mix. Operating income of £27.6 million was down slightly from £27.9 million a year ago. Moving on to slide 10, revenues and oilfield services for the quarter were £149.6 million, down 14% from £174.6 million in the third quarter last year. Gross margins of 36% were down 0.4 percentage points from last year's 36.4%. Operating income of 16.4 million was up 15% over the prior year. Turning to slide 11, corporate costs of the quarter were 19 million and within our expected range, compared with 17.4 million a year ago. The effective tax rate for the quarter was 17.5% compared to 20.9% a year ago, due mainly to the favourable geographical split of our profits. Moving on to slide 12, cash generation for the quarter was very strong with an operating cash inflow of £58.1 million before capital expenditures of £16.7 million. As of September 30th, 2023, Innerspec had £207.2 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. We are entering the fourth quarter with good momentum in all businesses, and we expect our balanced portfolio to deliver sequential improvement. We continue to execute on a diverse pipeline of organic growth opportunities. Cash generation was again excellent this quarter, and our net cash position strengthened to over $207 million. This quarter, we increased our semiannual dividend to $0.72 per share, bringing our full-year dividend to $1.41, representing a 10% annual increase. With our extremely strong balance sheet and a history of disciplined cash management, we are positioned to continue consistent shareholder returns, invest in organic growth, and pursue complementary M&A. With our foundation of world-class innovation and customer service, 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. Please stand by while we compile the Q&A roster. This will take a few moments. And now we're going to take the first question. And it comes from the line of John Tangbanteng from CJS Securities. Your line is open. Please ask your question.

Hi, good morning. Thank you for taking my questions. My first one is on the performance chemical segment. Congratulations on the nice quarter there. I was wondering how much of the sequential improvement was from new products and how much of the improvement was from legacy products recovering as we're destocking and you start selling more to end demand?

John, it was a pretty good balance of both. You know, we did the expansion in a couple of our sites, and we're starting to see that volume flow through in some of the heritage products and some of the new products. So it's really been a combination of both, and we expect that to continue into Q4 and into 2024 as well.

Where are you in the ramp of the new products? Did you only get, you know, maybe half of it in the quarter compared to the run rates you're expecting? How much is left as you go through the next couple quarters getting to the contracted run rates?

Yeah, we still have a ways to go. It's fairly early in the process. And, you know, the consumer is still a little hesitant. I mean, you know, there's a lot of conversations around destocking. We're not seeing it as drastic. I think that word's quite overused, quite frankly. except for probably markets like ag, et cetera. So it's still early in the process. The consumer is a little hesitant, so you do have some volume demand down. But I think that it's early in the process, and I think we'll see Q4 will tell us a lot going into 2024, but we're fairly cautious that this is going to be, when I say fairly optimistic, that 2024 is going to be a good year.

Got it. Okay. And then second, just on the oilfield business, it seems like you've found a steady state now after, you know, a year of really, really strong performance. Is this kind of the run rate you're expecting going forward into the next year or the opportunities for growth from these levels? How should we think about this business as you go forward? Have we kind of lapped that period?

Yeah, I think what you saw in Q3, you'll see in Q4, and that's probably the run rate going into 2024.

Okay, great. Last question, just any updates on the priorities for your cash?

Yeah, we're very cautious with our balance sheet. I know that people talk about burning cash in your pocket, but in markets like today, I think it's great because we're going to have a lot of opportunities. Our focus is organic growth. Our focus is to continue to increase our dividend. be flexible in the buyback, and just as important is looking at key acquisitions or mergers in our key markets. And we're starting to see a lot more activity in that area due to some chemical companies having stressed balance sheets and some private equity funds having stressed balance sheets. So, you know, I think it really bodes in our favor managing this business the way we are today, and I think we'll be opportunistic.

Okay, great. I will jump back in queue. Thank you. Thank you.

Thank you. Now we're going to take our next question. Just give us a moment. And the next question comes from the line of Mike Harrison from Seaport Research Partners. Your line is open. Please ask a question.

Hi, good morning. Good morning, Mike.

Good morning, Mike.

So I just wanted to follow up on the performance chemicals business. You seem to be fairly confident that you've seen destocking peak. I think some other personal care suppliers are out there saying that destocking is probably going to continue through year end. Can you maybe just give a little bit more color on what you're hearing from customers? and maybe why your business might be behaving a little bit differently than others in the personal care space.

Yeah, I think in the markets that we're primarily playing, the natural and natural beauty, et cetera, we've seen that peak. Depending on where other chemical companies play, there could be still some destocking. But I do think that that's a probably overused word. because we're seeing, if anything, we've probably seen volume destruction more than we have destocking. But from what we're seeing from the customers that we supply to and the indications that we're getting for Q4 and also moving into Q1, that we're starting to get back to some normalized order patterns. If you remember, the supply chain is more of You know, you cut the time in half where you supply products now to the customer. So there won't be this big ramp up once destocking is over. You know, it's not going to be let's restock everything. It's going to be more in-time inventory and on-time inventory. But I think for us, we're starting to see normalized inventories in this business.

All right. That's very helpful. And then switching over to fuel specialties. You noted that there was some additional inflation that maybe impacted your gross margins relative to your expectations. Do you expect that price-cost pressure to remain an issue into Q4, or is there some improvement coming? And then I guess just given the positive seasonal pickup in volume and mix as we get into the winter months, where do you think we should expect to see gross margins in Q4 and Q1?

I think Q4 and Q1, you're still going to see probably margins in the lower end of our range. You know, there's a big focus on fuels to obviously increase those margins, get those back into the mid to upper range. You know, typically in winter months, you have higher margin products, but with some of these inflationary pressures, they might normalize each other. So I think you'll see probably kind of the same type of margin profile in Q4 and Q1 and hopefully start to improve with the things that we're doing internally into Q2 and Q3 of next year.

All right. The last question for me is just maybe more of a housekeeping question for Ian. Where should we be expecting the tax rate to come in for Q4? And any early thoughts on tax rate guidance for 2024?

Yeah, Mike, it's an interesting question. What we've seen in Q3 is the geographical split of our profits towards our lower tax jurisdictions and also a consequence of having some of our operations outside the U.S. where they're exposed to foreign currency fluctuations. So that's been a tailwind for us. We think the effective tax rate for Q4 will be about 22%, so similar to where we were in Q3. And for next year, we think all those issues will sort of resolve themselves and we'll be back to that 25% to 26% range for the effective tax rate.

Excuse me, Mike. Any further questions?

No, I'm all set. Thank you. Thank you.

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

Hi. Good morning. Thank you. The first question, I would like to just kind of go back to performance chemicals and the idea that you're starting to ship under your new volume contracts. You know, I guess I was just trying to clarify, but you do have a internal expansion, capital expansion program underway that I believe was scheduled to be completed maybe mid- middle of next year, so not nine months or so from now. Is it your view that you can continue to fill these newer customer contracts, you know, based on the assets, the logistics and production and whatnot assets you have in place now? Or might there, you know, be a pause until, you know, the full internal discretionary CapEx program is in place?

Yeah, David. The good thing about that $70 million CapEx, it's done in phases. So you're not just throwing $70 million out to get one expansion. It's multiple reactors. We have slowed the program down. So we have slowed that CapEx down, but we have added reactors where we see volumes picking up. And we'll add a lot of that expansion going into next year as well, as long as we see You know the activity that we're seeing today, so we have slowed it down.

We do watch it extremely close And we will add those reactors and bring those on as we see those volumes coming on Okay, and then maybe just a somewhat broader question about resourcing or supporting your growth but when I Read through the press release, Patrick, I think, you know, you made kind of constructive comments near term, medium term about each of your three segments. I'd just like to hone in on two of them, personal performance chemicals and oil field. But, you know, those are areas, I think, where, you know, to meet the new higher level of demand that you're set up for, you know, you would need additional resourcing in terms of maybe not just personnel, but logistics, maybe some technical support, et cetera. How do you think Inispec is positioned here right now for the higher growth or higher level of business you anticipate over, let's say, the next six to 12 months? and maybe just a comment on talent acquisition and being able to get the people that you think you need to meet customer requirements.

Sure, David. Yeah, it's a good question. I think we're well positioned right now for the current growth that we're starting to see in all the businesses. I think, as you just alluded to, when you start moving up to the full $70 million expansion of what that means in revenue and what that means in technical service, supply chain, customer support, et cetera, you will have to bring some people on. We're constantly looking at talent depending on where we're going to place that talent and what our needs are. I think we've been a fairly attractive company to work for because we have a strong balance sheet, because we really work with incoming talent to train them into not only this business but what the needs are for the future of the company and where they fit in for the future of the company. So we do a lot of things in regards to attracting talent. The good thing right now is we're very well set. It would be very minimal the amount of people that we would need for the current growth rates that we're looking at. It's not like we're having to go out there and blanket the field to look at multiple people. It's a pretty limited amount of people that we're looking at to add on.

Okay, no, thank you for that. And then, you know, maybe just a couple of smaller, more focused questions, and I'll get back in queue. But one or two of my companies have had kind of a bit of a margin squeeze here, not so much from a management business perspective, but from an accounting perspective. And I guess it's maybe a FIFO versus LIFO issue. But those that have used FIFO have found that running maybe the costs from 60 to 90 days ago through the income statement and pairing it up with maybe the lower price points today, you know, maybe on a cost plus or a fixed margin arrangement, have led to, you know, a little bit of a squeeze from an accounting perspective here. And I just wanted to, you know, ask you about that if, you know, if that's an issue with your company or whether you think, you know, the current level of pricing is pretty well paired up with, you know, you know, the accounting for, you know, per unit cost items. Maybe just I'll stop there.

Yeah, David, we're pretty well paired up. We have seen some pressure in our fuel specialties and our performance chemicals business where we probably carry a little bit more inventory than we would like. We're working hard on lowering those levels of inventory. We're still seeing inflationary pressure, though, you know, Prices are not coming down across the board. Inflation is still there and that's still putting cost pressure across the business. But what's pleasing for us is that the way the business are managing the way through that. You've seen improved gross margins in fuel specialties this quarter and you've seen improved gross margins in performance chemicals. In fact, performance chemicals tipped over 20% for the first time this year. We're managing our inventory, we're managing our inventory volumes and our pricing well. Fuel Specialties is well understood in terms of the delay and the lag in pricing that we have. So we're not overly concerned. We just want to make sure that we're not carrying too much inventory for various reasons. It's not been a huge burden for us, but it's something that we do watch very carefully, David.

Okay, very good. And then maybe one last one, again, on fuel specialties here. But I may have missed this, but I believe in your prepared remarks, there was not really a mention of the role of, you know, aviation fuel additives as part of your overall mix, and maybe as a source of gross margins being a little bit below your target range. But the Maybe just an update on how that portion of your fuel specialties mix is progressing, and then also maybe just a comment on some of the newer initiatives, stationary power, et cetera. Thank you.

Yeah, I mean, Aptel is a very small portion of fuel specialties, and it gets smaller as we move forward. There is a lot of heat going on. in regards to getting tail out of low-lit gasoline, small piston aircraft. But we've been seeing that for years. So it's really nothing new. Now, do I think it could come before 2030 or 2032? It could. We're well prepared for it. But thankfully, it's a very, very small portion of fuel specialties. But we'll do what the industry needs. We'll supply the product as they need. And obviously, we'll take it out of the market when it's time. But I think we're well positioned to deal with Aptel. It's not as big of a product line in fuel specialties as we move forward. And fuel specialties, as you just said, is moving into greener paths. And that's where our focus is in this business.

Okay, very good. I'm going to get back in queue. Thanks for all the color.

Thank you. Now we're going to take our next question. Just give us a moment. At the next question comes the line of John from CJS Securities. Your line is open. Please ask your question.

Hi. Thanks for the follow-up. I was just trying to get a little more color on your fuel additives volume down 4% this quarter, down substantially more in the first half. I'm just wondering, are you selling to end demand at this point? Have you lost share? Or is this just where the market is and kind of what do you expect going forward just from a volume perspective?

No, it's just where the market is. We really haven't lost any market share. I mean, it's just, you know, this business just ebb and flows. And, you know, as we always say, it's not recessionary proof, but it's almost recessionary proof. You know, we'll have the ups and downs and quarters, but it's not necessarily that we've lost any big customers.

Okay, great. And is there any update on the potential recoveries from the Brazilian issue you had earlier this year?

Not really. We're going through the legalities of, you know, trying through the insurance and some civil and criminal legalities over in Brazil. We've replaced the individuals that were in charge of that business and we've got new individuals running it and we're off to the races and getting things fixed and improved.

Okay, great. And then last question, just assuming this is the run rate for oil field going forward at a revenue level, is there a chance to further improve the margin that you're seeing there? Or are you facing the same inflation concerns that maybe you're seeing in maybe fuel specialties or other portions of the business?

I think there's a little room for improvement on the margins. You know, you've still got high-cost raw materials, So you still do have some inflationary issues there. But I do think with some new technologies out there, we can improve the margins just a hair. That's a big focus of ours right now.

Okay. Is there any room to improve price if there's inflation?

Could be. There could be a little bit of room. That's somewhat stagnated, though. You know, that's kind of run its course.

Okay. Understood. Thank you, guys.

Thank you.

Thank you. There are no further questions for today. I would now like to hand the conference over to Patrick Williams for any 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 fourth quarter 2023 results in February. Have a great day.