Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Innophos Holdings Inc  (NASDAQ:IPHS)
Q4 2018 Earnings Conference Call
Feb. 20, 2019, 9:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Greetings, and welcome to the Innophos Fourth Quarter 2018 Earnings Conference Call. My name is Michelle and I will be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded.

I would now like to turn the call over to your host Mark Feuerbach, Vice President of Investor Relations. Mr. Feuerbach, you may begin.

Mark Feuerbach -- Vice President Investor Relations, Treasury, FP&A

Good morning and thank you for joining us today for Innophos' Fourth Quarter and Year-End 2018 Results Conference Call. Joining me on the call today are Kim Ann Mink, Chairman, President and Chief Executive Officer and Han Kieftenbeld, Chief Financial Officer.

Please turn to Slide Two. During the course of this call, management may make or reiterate forward-looking statements made in this morning's press release regarding financial performance and future events. We will attempt to identify these statements by use of words such as expects, believes, anticipates, intends, estimates and other words that denote future events. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important risks and other factors as set forth in the forward-looking statements section and in Item 1A Risk Factors in our Annual Report on Form 10-K as filed with the SEC that could cause actual results to differ from those in the forward-looking statements made in this conference call.

Also, I would like to remind you that during the course of this conference call management will discuss non-GAAP measures in talking about the Company's performance. Our adjusted EBITDA financial measure excludes stock-based compensation, currency translation, severance, value chain transition expenses, Mexico natural gas imbalance and supply adjustment charges, fair value inventory adjustments and M&A-related costs. Please refer to our press release, the appendix of today's presentation and our SEC filings for the GAAP to non-GAAP reconciliations.

We will make a replay of this conference call available for a limited time over the telephone at the numbers set forth in the press release and via webcast available on the company website. In addition, please note that the date of this conference call is February 20, 2019, and the presentation for this call can be found on our website at www.innophos.com in the Investor Relations Events section.

Any forward-looking statements we may make today are based on assumptions that we believe to be reasonable as of this date, and we undertake no obligation to update these statements.

Please turn to Slide Three. During the call today, management will be reviewing our fourth quarter and year-end 2018 financial performance and 2019 outlook, after which we will open the call up for questions.

With that, please turn to Slide Four, as I turn the call over to Dr. Kim Ann Mink.

Kim Ann Mink -- Chairman, Chief Executive Officer and President

Thanks Mark, and good morning everyone, and thank you for joining us today. 2018 was an important transition year for Innophos, as we executed against our Vision 2022 strategic road map by building the critical capabilities that will transform the growth profile of the company. Significant strides we made in advancing the multi-faceted strategic value chain repositioning initiative, developing innovative solutions that better serve our customers and enhance our position in attractive Food, Health and Nutrition end markets and capitalizing on our values selling commercial model.

On a full year basis, we grew sales by 11%, GAAP net income by 61% and adjusted EBITDA by 4%, all consistent with our expectations going into the quarter. Now in Q4, sales of $193 million were flat compared with the prior-year as a stabilized base business and pricing power were partially offset by lower nutrition sales resulting from our previously announced decision to discontinue a portion of low-margin nutrition trading business.

GAAP net income for the quarter was $5 million, or $0.24 per share, which was 143% ahead of Q4 2017 due primarily to tax reform changes in the prior year. Q4 adjusted EBITDA of $30 million was up 10% and adjusted EBITDA margin of 15% was up 143 basis points as higher input costs were fully offset by the benefits of selling price increases and lower operating expense.

Further by remaining disciplined with the management of our liquidity position, we reduced our debt and realized net leverage up 2.2 times. Now by taking actions to proactively manage near-term market dynamics, while advancing our key initiatives under our Strategic Pillars, we are entering 2019 with good momentum. Our priorities this year are to execute against these initiatives in order to pursue our Vision 2022 goals and deliver long-term value for our customers and shareholders.

Please turn to Slide Five. Now before moving onto strategic highlights, I want to note that despite the headwinds we faced throughout 2018, we achieved year-over-year revenue and EBITDA growth and importantly, sequential stability across key metrics. Notably, 2018 revenue grew compared with 2017, as acquisitions and pricing actions in our base business more than offset operations related issues and the discontinuation of select low-margin nutrition trading business in the second half of 2018. Adjusted EBITDA was up on a full year basis and was also sequentially consistent throughout the year.

With that, I would like to take a closer look at some of the key achievements in 2018 under our Strategic Pillars, so please turn to Slide Six. In operational excellence, significant progress was made throughout the year in advancing our strategic value chain repositioning initiative with the completion of major milestone. This included, the signing of strategic PPA and MGA supply agreements and we see of the negotiated $20 million payment to offset near-term value chain specific transition charges, as well as the long lead-time environmental and operational government permits.

We also advanced the multi-faceted CapEx investments to increase the self-sufficiency of MGA supply from the Coatzacoalcos facility and switched the Geismar facility to the new multi-source supply structure. The transition of the multi-faceted supply chain is expected to continue through the first half of 2019, with the benefit of the lower cost structure being captured during the latter half of the year. Now we do remain on track to deliver adjusted diluted EPS improvement of 10%, which represent an estimated annual run rate of $0.25 to $0.27 per share.

Additionally, in Q4 we completed our Phase II operational excellence program capturing a total of $5 million of savings in 2018, across raw material purchases, MRO ports and labor and planning and logistics. This did fall short of the Phase II operational excellence savings target of $9 million due to the unprecedented increases in freight market rate.

Now under Commercial Excellence, our commercial organization has continue to successfully leverage our pricing power to offset input cost increases from inflation and higher freight expenses. We have made great progress in involving our go-to-market value-selling model. We now have cross-functional market segment teams in place that will leverage our expertise across innovation, technology, marketing and sales and the shift to a value-based selling approach has enabled Innophos to more effectively understand the market and customers we serve. This has been key in supporting our efforts to capture price increases and in driving success with new product development initiatives under the strategic growth pillar.

Now under Strategic Growth, we remain focused on advancing both organic and inorganic growth opportunities that strengthen Innophos' position as a value-adding higher margin ingredient solutions provider for high growth FHN market. Now on the organic side, we do continue to deliver wins through our SPARC new product development program. These efforts leverage our acquired and legacy capabilities as well as our cross-functional commercial models. They also support our strategy to shift our portfolio mix over time to a greater level of higher margin, higher value branded ingredient and formulated solutions.

So for example, during the fourth quarter, we have launched a new proprietary herbal blend for a well-known global consumer health company. This new product required specialized processing to deliver specific properties that support the launch of two new product forms, chewable and effervescent tablets, under a well-known brand supporting immune health.

Our formulators also developed a custom blend of health promoting minerals and vitamins for children's chewable product launched in Asia for one of our global dietary supplement customers. And finally supporting the demand by today's active consumers for nutrition derived from natural, plant-based sources, we've launched a vegan mineral complex for a new dietary supplement for the sports nutrition market.

We also continue to actively evaluate M&A opportunities to drive inorganic growth that meet our disciplined and requisite, corporate strategic and financial criteria to strengthen our FHN platform. At this stage in our transformation, our three strategic pillars are deeply ingrained in the Innophos culture and highly interconnected. So, looking forward to 2019, our focus is on executing on the key initiatives across our strategic pillars. And by doing so, we are positioning Innophos to deliver improved profitability and realigns our Vision 2022 goals for sustainable top and bottom line growth.

So with that, I'll now turn the call over to Han. Han?

Han Kieftenbeld -- Senior Vice President & Chief Financial Officer

Thank you Kim Ann, and good morning everyone. Please turn to Slide Seven. Before I review the details of our Q4 financial performance, I would like to note key financial highlights for the quarter. Q4 revenue of $193 million was in line with our guidance and the prior year. Adjusted EBITDA also in line with our guidance was up 10% year-over-year with an adjusted EBITDA margin of 15%, reflecting base business, price increases that exceeded input cost increases. We ended the year with a strong cash position including $52 million of free cash flow generated in the quarter, which is triple the prior-year quarter, as we received the $20 million Nutrien payment and $23 million from the sale leaseback transaction.

Now let's turn to Slide Eight to take a closer look at the quarter details. Sales of $193 million in the quarter were flat year-over-year, as the 3% increase in the base business was offset by the discontinued portion of low-margin nutrition trading business, which we communicated in Q3. Volumes were down 7%, while average selling prices were up 7%.

On a full-year basis, our sales improved by 11% versus 2017, reflecting the benefit of our acquisitions and proactive pricing programs that have offset input cost increases. Q4 gross margin was 15% down 147 basis points from the prior-year quarter due to the impacts from the value chain transition charges, higher energy cost and the write-off of mining concessions in Mexico, an action we decided to take as the mining rights acquired in 2009 do not align with our strategy. Excluding the impact from these cost increases, Q4 gross margin would have been 19% of sales. For the full-year, gross margin was impacted by the same factors.

Moving on to earnings on Slide Nine. Q4 net income of $5 million was 143% higher than the prior year due to tax reform provisions booked in the prior-year quarter. Adjusted EBITDA of $30 million was up 10% compared with last year, which included a Mexico plant maintenance outage. As shown on the adjusted EBITDA bridge, selling price increases offset lower volumes and higher input cost in Q4 and for the full year.

Moving on to Slide 10 to review our performance by segment. FHN Q4 sales of $113 million represent a 58% of total company sales and were down 2% overall, as the 5% increase from prices was offset by an 8% decrease in volumes, due largely to our decision to discontinue a portion of low-margin nutrition trading business.

On a full year basis, the FHN segment represented 60% of the year sales, an increase from 55% in 2017. FHN Q4 adjusted EBITDA margin of 15% was sequentially similar to the past two quarters, but 377 basis points below Q4 2017 due to continued increases in freight market rates and other input cost.

IS Q4 sales were up 1%, as a 7% selling price increase was largely offset by a 5% volume decline. The IS Q4 adjusted EBITDA margin of 15% was significantly above the same quarter last year due to improved selling prices in 2018 and a favorable comparison from the maintenance outage effects in Q4 of 2017. Other Q4 sales were $15 million, up 11% compared with the same period last year, as higher co-product selling prices more than offset lower volumes. Other adjusted EBITDA margin of 22% was up 90 basis points from Q4 2017.

Now turning to Slide 11. In the fourth quarter, net interest expense of $4 million was up $1 million due to higher average debt levels along with higher market interest rates. The underlying effective Q4 tax rate were 38%, higher-than-expected due to foreign exchange effects, which have been taken out for adjusted diluted EPS. The Q4 rates normalized for these FX effects was 30%.

Capital expenditures of $13 million in the quarter were $3 million higher than prior year mostly due to the value chain reposition and manufacturing optimization initiatives. We paid $9 million in dividends during the quarter and maintained our annual dividend rate of $1.92 per share.

Net debt was $280 million in Q4, down $1 million year-over-year, as we remain disciplined with the management of our liquidity position. Our net debt-to-adjusted-EBITDA ratio was 2. 2 times compared to 2.3 times last year. In December, we proactively put an interest rate swap in place fixing LIBOR at 2.677%. This rate will be valid for three years on a $150 million of our debt.

Now turning to Slide 12. On a GAAP basis, earnings per share of $0.24 was up a 142% due to tax reform provisions taken in the prior-year period. Q4 adjusted diluted EPS was $0.54, up $0.02 or $0.03 -- 3% year-over-year as the high EBITDA contribution was largely offset by higher adjusted tax rate of 30% in the current year versus 17% in the prior year.

Moving to Slide 13. Q4 cash from operations was $43 million and free cash flow was $52 million, three-times the prior-year quarter, reflecting the receipt of the $20 million Nutrien payment and $23 million from the sale lease-back transaction. Average working capital for the quarter and for the full year 2018, was 23% of sales.

Now turning to our revenue outlook on Slide 14. Overall market conditions and the competitive landscape in 2019 are expected to be similar to 2018. Revenues are expected to be largely in line with 2018 revenue of $802 million and approximately equally split between H1 and H2. The underlying base business is expected to remain stable.

Positive year-over-year contributors to 2019 revenue are: Selling price increases with a particular focus on Food, Health and Nutrition, new product development wins, and new business gains. These gains are expected to be offset by: The discontinuation of lower margin FHN nutrition trading business in 2018, lower co-product sales in the Other segment due to efficiency improvements delivered from the strategic value chain initiatives, and indirect tariffs pressure from competition redirecting mostly technical grade product to international markets. We anticipate limited direct impact on our North American sales.

Now turning to our earnings outlook on Slide 15. Adjusted EBITDA is expected to grow 1% to 3% in 2019 from $125 million in 2018, with phasing in the range of 42% to 45% in H1 and 55% to 58% in H2. Positive year-over-year contributions to 2019 earnings are expected from: Selling price increases, margin contribution from business gains and new product development, and the strategic value chain program, which is on track to realize adjusted diluted EPS improvement of 10%, or $0.25 to $0. 27 per share run rate by the end of 2019.

These gains are expected to be partly offset by: Input cost increases for raw materials and freight, and higher costs related to Mexico energy supply shortages that are expected through H1 of 2019. The anticipated non-recurring portion is expected to be adjusted for non-GAAP purposes.

From a GAAP and cash perspective, the expectation is that costs will be higher during H1. The anticipated non-recurring portion is expected to be adjusted for non-GAAP reporting purposes such as value chain transition expenses and Mexico natural gas supply adjustment charges.

Capital investments are expected to be in line with 2018 to finalize the value chain and manufacturing optimization program that commenced in 2018. Average working capital is estimated to remain in line with 2018. The company expects its effective tax rate to operate in the 28% to 32% range.

With that, I'll turn the call back over to Kim Ann.

Kim Ann Mink -- Chairman, Chief Executive Officer and President

Thanks Han. And before we open the call up for questions, please turn to Slide 16, as I highlight a few key points. Now although we expect to face some headwinds in 2019, our base business remains stable and we are confident that we have the critical capabilities in place under our strategic pillars to deliver on our promise to generate sustainable value for our shareholders, our customers and our employees.

Now in 2018, we made exceptional progress with the complex, strategic value chain initiative and as a result, we are on track to meaningfully reduce our cost bases, as we move through 2019. Through our commercial excellence work, we have established deep customer relationship that are supported by a cross-functional go-to-market model and insights-driven value proposition and the strong commercial foundation positions us to continue to proactively leverage our value-selling approach.

We also have excellent momentum with the SPARC program and expect to accelerate our rate of new product introductions, as we move through the year. And finally, our M&A pipeline remains active and we are committed to pursuing further inorganic growth initiatives that shift our position over time to value-adding, higher-margin ingredient solutions provider. We look forward to keeping you updated, as we execute on our plan and continue on the path to deliver our longer term Vision 2022 goals.

So with that, we'll now open the call for questions.

Questions and Answers:

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Larry Solow with CJS Securities. Please proceed with your question.

Larry Solow -- CJS Securities -- Analyst

Hi. Good morning, guys. Thanks.

Kim Ann Mink -- Chairman, Chief Executive Officer and President

Hi Larry. How are you?

Han Kieftenbeld -- Senior Vice President & Chief Financial Officer

Good morning.

Larry Solow -- CJS Securities -- Analyst

I'm doing great. Could you just maybe give us, Han maybe or Kim Ann, just a little more color on the sales outlook. It sounds like this price increases are sort of offsetting the calling activity in your base business. And then there's a little bit of stuff in the other in the tolling business that's impacting you. And maybe a little bit impact from tariffs.

But just on the base business, novel ingredients and the other nutritional business, are they still growing sort of at the 6% to 8% rate, you'd thought? And then maybe phosphates are more flat to slightly up? I know you mentioned price increases, but those seem to be more just some reaction to the higher cost basis. So, could you just give us a little more volume look, and what's driving the revenue?

Han Kieftenbeld -- Senior Vice President & Chief Financial Officer

Yes. So, Larry this is Han. Good morning. So, if we look just at the past quarter and then I'll talk to you a little bit about the looking ahead. We obviously saw the impact. We mentioned it in the remarks that we just made from the low-margin nutrition. If you actually look and you asked specifically about the acquisitions, we did see volume growth to the tune of 3%. But if you actually take out that particular fact and the decision we made, we're closer to 6%. So, actually, so that's in line with, where we expect it to be as you mentioned the range. So, that just a little bit of a background of information.

Looking ahead, obviously from a year-over-year comps perspective, we will not have that piece of business. And you also mentioned indeed there was a piece in the Other segment, which is the co-product sales due to the efficiencies that we're going to realize in our Coatzacoalcos facility that we will no longer have. So, we're kind of starting up from a little lower base if you will, that's the way to think about it. And then as we're growing back, we're growing back our revenue and that's why we said in line with 2018. But make no mistake, there was actually underlying growth in both the phosphates and the nutrition portfolio to actually get us back to that same level.

Kim Ann Mink -- Chairman, Chief Executive Officer and President

Right. And, Larry, if you strip all those factors out, the company would be showing growth at the top-line just over 3%.

Han Kieftenbeld -- Senior Vice President & Chief Financial Officer

Yeah.

Larry Solow -- CJS Securities -- Analyst

But it seems to me that the mix of your revenue is certainly getting better obviously right? You're intentionally calling out some of the lower-margin stuff, which I know you did for a couple of years and then you had stopped and then I guess this is in relation to novel more, you know, more novel. But and then obviously some of the stuff that's also dropping off is the tolling stuff, which I imagine at the end of the day on the bottom line profit is not driving much of a drop.

So, I'm now just trying to struggle a little bit with why the EBITDA number is sort of -- is it just -- because if we look back last year, your guidance for '18 was $140 million, and we're now in 2019 and we're only guiding to under $130 million. So, I'm just trying to sort of gap the two if you will?

Han Kieftenbeld -- Senior Vice President & Chief Financial Officer

Yeah. So, if you look at this year's jump off point, obviously, so the $125 million, we see obviously some margin impact from, albeit small, from the business that we talked about in terms of that being discontinued, if you take that into consideration. The other factors are obviously there is continued input cost and freight market rate increases that we factor in this outlook.

The other thing that is -- that is there is, we talked about the Mexico energy component that is -- that is still sizable it was in Q4 and we see that. For now at least based on the best information we have, we see that for the first half of 2019, but obviously, we're seeing to take stock as we learn more about that. But those are factors Larry on the downside that we see.

Now on the positive side, we see wins from NPD, so new product development. We see gains, business gains particularly in our nutrition portfolio to make up for some of the discontinued business. And then thirdly, our continued focus on value selling and the selling price increases, those are the three factors that we see to more than offset some of the downside that I just mentioned.

Kim Ann Mink -- Chairman, Chief Executive Officer and President

Yeah, so Larry I would sort of summarize all that. We're really providing what we believe is a realistic view of the year, given the factors that we're aware of. We're really focused on controlling the factors that we can control, things like NPD, things like pricing, by closely monitoring those that we can. And those are those, if you kind of think of the three buckets that are impacting us from an earnings standpoint: The Mexico energy.

Larry Solow -- CJS Securities -- Analyst

Right.

Kim Ann Mink -- Chairman, Chief Executive Officer and President

The continuing increase in freight charges; and those in-direct impacts from tariffs, if you think about those three buckets. So, again base business stable. We're seeing actually increase, but if you take away -- when you take away the headwinds, but those headwinds are real.

Larry Solow -- CJS Securities -- Analyst

Right. That's fair enough. And just on the value chain initiatives and I know your guidance, you have certainly more back-end loaded. Do you start getting some of that benefit in '19? I mean is there any way to sort of save that $0.20 $0.25, you achieve x percent in '19 and the rest in '20. Is it, it sounds like majority is in '20, but is there a piece in '19 that you actually realize?

Han Kieftenbeld -- Senior Vice President & Chief Financial Officer

Yes, there is Larry. So, the way we're looking at it right now and obviously we're going through this transition still in the first half of 2019, making sure that everything is lined up in terms of our storage, our supply chain with the new supply mix, if you will. What we expect is to see an effect that's what we factored in for this outlook right now is for the second half, OK. So, if you look at that number and you look at the $0.25 to $0.27, we factored in the second half component of that.

Now the one thing that we've mentioned before is always that we hold approximately a quarter worth of inventory, so that basically means that as we get to realize this benefit is pretty much takes an average of three months to actually go through the system, if you will, from the balance sheet into the P&L. But just to be crisp on the answer, the answer is, is that we factored in half of -- for the second half of the benefit that we've talked about.

Kim Ann Mink -- Chairman, Chief Executive Officer and President

And Larry one last item I would add is just to put it into context, it's taking the first half of the year to really optimize the new supply structure, and hence the reason, why the benefits are more back-end loaded.

Larry Solow -- CJS Securities -- Analyst

Okay, fair enough. And then just how about, lastly, I realize the acquisitions are not an exact science and I imagine that the queue is still very full, but just globally can you give us sort of an update, I know, you guys have targeted, sort of, I guess almost getting EBITDA to double with the sort of rate we're at today and that by 2022 is that maybe a little bit pushed out now, or is it any thoughts on that?

Kim Ann Mink -- Chairman, Chief Executive Officer and President

Yes, no, I can start here. Our pipeline remains very active. And as we've spoken about in the past, we're looking at target acquisitions that are really going to build on the novel and NutraGenesis acquisition is really strengthening that FHN platform. I can say we continue to be actively pursuing our M&A agenda and evaluate opportunities, but we are disciplined and we look at our financial and strategic fit criteria.

With regard to Vision 2022, we are on track. We do remain on track to hit that $1.25 billion, which as we discussed and as we rolled out our Vision 2022, $475 million of that would come from M&A. So, we do remain on track that was actually, when we put that Vision 2022 out, that was actually looking at getting our first tranche, if you will, of new acquisitions in the 2018 timeframe and we actually bought them in 2017. So, we still remain confident about that direction.

Larry Solow -- CJS Securities -- Analyst

Great. Okay, excellent. Thank you.

Operator

Thank you. (Operator Instructions) There are no further questions at this time. I would like to turn the call back over to Ms. Mink for any closing remarks.

Kim Ann Mink -- Chairman, Chief Executive Officer and President

Sure. Thank you, Michelle. I want to thank everyone for joining us today and we look forward to keeping you updated on our progress throughout 2019. Thanks again, and have a great day.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.

Duration: 33 minutes

Call participants:

Mark Feuerbach -- Vice President Investor Relations, Treasury, FP&A

Kim Ann Mink -- Chairman, Chief Executive Officer and President

Han Kieftenbeld -- Senior Vice President & Chief Financial Officer

Larry Solow -- CJS Securities -- Analyst

More IPHS analysis

Transcript powered by AlphaStreet

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.