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

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today's Innospec Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session (Operator Instructions). I must advise you that your conference is being recorded today, on Wednesday, the 20th of February 2019.

I would now like to hand the conference over to your speaker today, General Counsel, David Jones. Please go ahead, sir.

David Jones -- Vice President, General Counsel and Chief Compliance Officer and Corporate Secretary

Thank you for joining our fourth quarter 2018 and year-end 2018 financial results conference call. Today's call is being recorded. As you know, late yesterday, we reported our financial results for the full year and quarter ended December 31, 2018. The press release is posted on the Company's website innospecinc.com. The slide presentation on the results is now available on our website and both an audio webcast and the slide presentation will be archived on the website for six months.

Before we start, I would like to remind everybody that certain comments made during this call might be characterized as forward-looking statements. Generally speaking, any comments regarding management's beliefs, expectations, targets or other predictions of the future are forward-looking statements. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from anticipated results implied by those forward-looking statements. These risks and uncertainties are detailed in Innospec's most recent 10-K report, as well as other filings we have with the SEC. We refer you to the SEC's website or our site for these and other documents.

In our discussion today, we have also included some non-GAAP financial measures. A reconciliation to the most directly comparable GAAP financial measures is contained in our earnings release, a copy of which is available on the website.

With us today from Innospec are Patrick Williams, President and Chief Executive Officer, and Ian Cleminson, Executive Vice President and Chief Financial Officer.

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

Patrick Williams -- President and Chief Executive Officer

Thank you, David. And welcome everyone to Innospec's fourth quarter and full-year 2018 conference call. I am pleased to be reporting another very positive quarter for Innospec, which completes the most successful year in the Company's history. For many years, our vision has been to transform ourselves from a one-product company into a thriving, profitable, global specialty chemicals business. We have successfully achieved this vision to date and have created a very solid foundation from which we will further enhance growth and profitability. Even with the expected decline in our Octane Additives business, we set record revenues of $395 million for the fourth quarter, up 12% on last year and close to $1.5 billion for the full year, an increase of over 13%.

Our businesses have operated in an inflationary environment, but we have continued to manage costs well, resulting in adjusted EPS for the quarter of $1.62, another record for Innospec. Excluding Octane Additives, the core businesses are up 25% on the same quarter last year.

I am particularly pleased that these improvements in our business have been driven directly by our strategy. We have continued to grow in our chosen markets and we have also delivered significant sustainable gross margin improvements, which help further increase our profitability.

2018 was always going to be extremely challenging year for cash flow. Not only did we need to increase working capital to support the sales growth of our strategic businesses, but we have a number of very exciting organic growth projects, which have required capital investment during the year. Despite this outflow, we have delivered excellent cash generation, which has brought our leverage down significantly with net debt now at approximately 0.5 times adjusted EBITDA.

Fuel Specialties has made good progress this year, with strong volume growth, driven by continued introduction of new technologies. Gross margin in this business do vary quarter-by-quarter and we are at the lower end in the fourth quarter, but they have remained within our expected range throughout the year and we see no reason for this to change in the near future.

Performance Chemicals has continued to grow faster than the market, increasing revenue by 12% over the year. It has also delivered a steady improvement in gross margins which we signaled will be the basis of our strategy.

Our research and technology pipeline delivered further new and exciting products and we have announced investments in our R&D centers of excellence, adding a number of new and experienced hires to our highly qualified team.

It has been a volatile year for everyone in the oil and gas industry. With these challenges, I am very pleased with the improvements in our Oilfield Services business. Even as crude oil prices softened toward the end of the year, we have delivered consistent sales growth and full-year sales up 32% on 2017.

Our focus on gross margins has resulted in an improvement both sequentially and compared to prior year. Combined with tight cost control, this has helped drive our full-year operating income by more than double over last year.

As anticipated, Octane Additives completed the one order from the last remaining customer during the fourth quarter. Full-year sales were a little over 50% of the 2017 revenue, which was very much in line with our expectations. The outlook for this business is unchanged. We have no orders on hand, although we do believe that we will receive one further order in the first half of 2019.

Now, I will turn the call over to Ian Cleminson, who will review our financial results in more detail. Then I'll return with some concluding comments. And after that, we will take your questions. Ian?

Ian Cleminson -- Executive Vice President & Chief Financial Officer

Thanks, Patrick. Turning to slide 7 of the presentation, the Company's total revenues for the fourth quarter were $395 million, a 12% increase from $353.8 million a year ago. Overall, gross margin decreased from last year to 29.5% driven by the reduction in the Octane Additives business and lower margins in Fuel Specialties.

Adjusted EBITDA for the quarter was $55.1 million, the same as the fourth quarter of 2017 as the decline in Octane Additives and the restructuring charge associated with the closure of our Everberg site was offset by the improvements in our strategic businesses.

Net income for the quarter was $20.4 million compared to a net loss of $4.8 million last year, with both periods adversely impacted by US tax reform adjustments.

Our GAAP earnings per share were $0.83 including special items, the net effects of which decreased our fourth quarter earnings by $0.79 per share. A year ago, we reported a GAAP loss of $0.20 per share, which include the negative impact from special items of $1.67. Excluding special items in both years, our adjusted EPS for the quarter was $1.62 per share, a 10% increase from $1.47 per share a year ago, despite the decline in Octane Additives.

For the full year, the total revenues at $1.5 billion increased 13% from $1.3 billion in 2017. Net income for 2018 was $85 million or $3.45 per diluted share compared to $61.8 million or $2.52 per diluted share a year ago. Special items decreased net income for the full year by $33.9 million or $1.38 per diluted share in 2017. Similar items decreased net income by $52.5 million or $2.14 per diluted share.

Excluding special items in both years, our adjusted EPS for the year was $4.83 per share, a 4% increase from $4.66 per share a year ago.

Adjusted EBITDA for the year was $187.4 million, broadly similar to 2017 despite the decline in Octane Additives and the restructuring charge associated with the closure of our site at Everberg.

Moving on to slide 8, revenues in Fuel Specialties for the fourth quarter were $162 million, 11% higher than the $146 million reported a year ago. Volumes grew by 13%, offset by an adverse currency impact of 2%. Sales growth was very positive in all regions, with excellent volume growth of 16% in the Americas. Fuel Specialties gross margin for the quarter was at the lower end of our expected range, at 32.8%, down 3 percentage points on the comparative quarter last year, due mainly to sales mix.

Operating income for the segment was $35.6 million, up 12% on the same quarter last year. For the full year, Fuel Specialties revenues were up 10% to $574.5 million and operating income was up 8% to $116.3 million.

Turning to slide 9, revenues in Performance Chemicals for the fourth quarter increased to $110.4 million from last year's $109.8 million. Sales grew by 1%, driven by volume growth of 7%, offset by a price mix effect of 4% and negative currency impact of 2%.

Gross margin for the segment was up 1.7 percentage points for the quarter to 20.8%. Operating income for the quarter was $10.5 million, broadly in line with the fourth quarter last year.

For the full year, revenues increased 12% from last year to $468.1 million. And operating income increased 37% to $44.7 million.

Moving on to slide 10, our Oilfield Services business grew strongly in the fourth quarter despite the softening of the price of crude oil. Revenues were $108.5 million, up 36% on the fourth quarter of 2017, driven by sustained customer activity. Volume growth of 29% was augmented by a favorable price mix impact of 7%.

Gross margins improved to 34%, up 1 percentage point from the same period last year and up 1.9 percentage points sequentially. Operating income increased to $8 million compared to $1 million in the same quarter last year.

For the full year, revenues were up 32% to $400.6 million and operating profit was $22.1 million, more than double the $9.5 million earned in 2017.

Moving on to slide 11, revenues in Octane Additives for the quarter were in line with expectations at $14.1 million as we delivered the full quantity of the latest order, but down from the $18.1 million in last year's fourth quarter. The segment's gross margin was 25.5%, driven by the sale of higher volume inventory and higher unit costs due to lower production volumes. Operating income for the quarter was $3.4 million compared to $7.5 million a year ago.

For the full year, as we expected, Octane Additives revenue was $33.7 million, down 43% on the same period last year, and operating income was $9.9 million, down from $26.7 million in 2017.

Turning to slide 12, corporate costs for the quarter were within our expected range at $12.3 million, down $1.2 million from the $13.5 million in last year's fourth quarter. The full-year adjusted effective tax rate was 23.7% compared to 20.2% a year ago.

Income tax expense was $21.6 million for the quarter compared to $45 million for the fourth quarter of 2017 and both periods include the impact of the US tax reform. The full-year charge was $46.6 million compared to $66.3 million for 2017. For 2019, we expect the full-year effective tax rate to be approximately 27%.

Moving on to slide 13, we had a very strong cash flow in the quarter with net cash generated from operations at $69.8 million before capital expenditures of $9.3 million.

Operating cash generation for the fourth quarter last year was $47.5 million. There were no share repurchases during the quarter, but we paid the previously announced semi-annual dividend of $0.45 per share. This brought the total dividend for the full year to $0.89 per share, representing a 15% increase year-over-year. For the full year, net cash generated from operations was $104.9 million compared to $82.7 million during 2017.

As of December 31, 2018, Innospec had a $123.1 million in cash and cash equivalents and total debt of $210.9 million, reducing our leverage from around 0.7 times adjusted EBITDA at the beginning of the year to around 0.5 times at the year-end despite significant investments in both fixed and working capital.

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

Patrick Williams -- President and Chief Executive Officer

Thanks, Ian. This has been a strong quarter to conclude a very good year Innospec's continued profitable growth strategy.

Against a background of challenging markets and with softer crude oil pricing toward the end of the year, we have still been able to deliver record sales in all our strategic businesses.Our adjusted EPS was also at record levels even with the decline in Octane Additives. Excluding this, our adjusted EPS was up 25% on the same period last year, with all our strategic businesses making significant contributions.

All of our core businesses have performed well. Fuel Specialties delivered solid volume growth, while the focus on margin improvement in Performance Chemicals has improved profitability as we anticipated.

Oilfield Services has not only shown excellent volume growth, but also improved margins, which has translated into a substantial improvement in operating income, right in line with our expectations. We invested a significant amount of cash in both working capital and organic growth projects during the year, but we're still able to deliver great cash flow, which has reduced our net debt to around 0.5 times adjusted EBITDA.

We have a very strong and solid company with great financial foundations. Our strategy continues to resonate well with our customers as we invest in exciting new technologies. We will continue to focus on growing organically, while having the balance sheet strength to take advantage of any potential acquisition opportunities, which will further deliver shareholder value.

2019 has the potential to bring some very tough challenge driven by the instability in the global geopolitical environment. However, Innospec has create a very solid business foundation from which we can rise to those challenges. We start 2019 with great momentum and optimism and we expect to continue to deliver to our customers and shareholders.

Now, I'll turn the call over to the operator and Ian and I will take any of your questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Thank you. And your first question comes from Jon Tanwanteng from CJS Securities. Please go ahead, sir.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Good morning, gentlemen. Thank you for taking my questions. And a very nice quarter.

Patrick Williams -- President and Chief Executive Officer

Thanks, Jon.

Ian Cleminson -- Executive Vice President & Chief Financial Officer

Thank you, Jon.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Did you see any major swings by month in Oilfield and kind of what drove the overall strength in Q4, especially relative to the decline in crude prices?

Patrick Williams -- President and Chief Executive Officer

Yeah. I think, as you remember, Jonathan, our strategy was primarily to really look at the low lift cost basins. And so, we've actually spread out our customer base in those basins, I think, with great technology. It's just a credit to our management team we don't get tired. It's continuously efforts to improve not only technology, but out in the field. And so, it really hasn't been driven by one technology or one customer. It's been spread out equally among all the divisions.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay, great. And have you seen that momentum carry into Q1 and how do you think of the year?

Patrick Williams -- President and Chief Executive Officer

No, we have. We really haven't seen a slowdown. We saw a little bit edge down in December, which you would expect, obviously, with the holidays coming about and crude oil prices, at that time, had slipped quite significant. But with crude rebounding and we typically get to see about three months in advance on some of these crews and we started off fairly strong in the year.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay, great. Thank you. Moving to the Chemicals segment, you had a really nice growth rate as you started the year and that kind of trailed off. How should we think of that progression as we go into '19? What are the year-over-year factors that can contribute to the growth there?

Patrick Williams -- President and Chief Executive Officer

Yeah. It's typical in that industry to see some destocking in Q4. You'll see that almost every year. And we saw it again in 2018. We would suspect that the growth rates were well beyond the typical market growth rates. So, we would suspect probably 5% to 7% on revenue growth in that business, with some increasing in the GP and a little bit increase in OI as well.

Ian Cleminson -- Executive Vice President & Chief Financial Officer

Jon, it's just worth noting that, in Q4, we did see 7% volume growth year-over-year, which is a good indication that the underlying market and, certainly, our technology is in really good shape.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Got it. Okay. And then, Ian, just help me understand what drove the cash flow in the quarter. Was there anything lumpy or specific that's going to impact 2019 at all?

Ian Cleminson -- Executive Vice President & Chief Financial Officer

No, just some great management focus. We were a little bit slow in the first half of the year and all our management teams turned their attention to working capital management and cash flow generation. And they did a superb job. It was accelerating in Q3 and Q4 was exactly what we hoped and expected for. So, full credit to the guys out there.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay, great. And then, just one overall comment on input prices, how have they been trending and what do you expect going into the new year?

Patrick Williams -- President and Chief Executive Officer

Prices, they are pretty steady. They came down briefly when crude prices slipped off. But anything between $50, $60 range. Prices were pretty steady. You're not going to see a jump one way or the other.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay, great. Thank you very much, guys.

Patrick Williams -- President and Chief Executive Officer

Thank you.

Ian Cleminson -- Executive Vice President & Chief Financial Officer

Thanks, Jon.

Operator

Thank you. Your next question comes from Curt Siegmeyer from KeyBanc Capital. Please go ahead, sir.

Curt Siegmeyer -- KeyBanc Capital Markets -- Analyst

Hey. Good morning, guys.

Patrick Williams -- President and Chief Executive Officer

Good morning, Curt.

Curt Siegmeyer -- KeyBanc Capital Markets -- Analyst

Hey, on Fuel Specialties, I know you talked about some of the new product launches that seem to have helped in the quarter drive that double-digit growth. But I was wondering if you could give a little bit more color there, especially the Americas region, up 16%. It was pretty impressive. Just what some of those drivers were. And then, how you expect that to -- you always talk about this business being kind of low-single-digit grower over the long term, but you've been able to outpace that for quite a few quarters in 2018. So, just wondering if you can talk about that a little bit?

Patrick Williams -- President and Chief Executive Officer

Yeah. You know (inaudible) it's based on technology and continued improvements in technology. And so, one of the things that we've introduced is new technology to the market. So, we've not only expand the customer base, but I think that some of the products that were somewhat falling off in 2017 have picked back up, like Cetane. So, some of those products have come back to the market, some of it is customer expansion and a lot of it really is down to new products and new technologies. And so, yeah, we've outpaced the market. I think we're still going to stick to that 2% to 3% above GDP, is probably a good number for 2019.

Curt Siegmeyer -- KeyBanc Capital Markets -- Analyst

Okay. Can you give us an update on the latest on the GDI opportunity, if there's anything new to talk about there?

Patrick Williams -- President and Chief Executive Officer

It's still ongoing. There's a lot more movement, I would say, in Europe than there is in US. It's continued to be a technology that will make its way into the market at some point in time. It's making its way into the aftermarket, but that's a fairly small market at this point. So, really, as more GDI vehicles come up out and more PFI vehicles drop off, you'll see more of an increase in GDI. But it's going to take time. We don't see a lot of big sales into that probably until sometime in 2020.

Curt Siegmeyer -- KeyBanc Capital Markets -- Analyst

Got it. Thanks, Patrick.

Patrick Williams -- President and Chief Executive Officer

Thank you.

Operator

Thank you. (Operator Instructions)

Your next question comes from Chris Shaw from Monness, Crespi. Please go ahead, sir.

Christopher Shaw -- Monness, Crespi, Hardt & Co. -- Analyst

Good morning, guys. How are you doing?

Patrick Williams -- President and Chief Executive Officer

Good, Chris.

Ian Cleminson -- Executive Vice President & Chief Financial Officer

Good, Chris. How are you?

Christopher Shaw -- Monness, Crespi, Hardt & Co. -- Analyst

Good, thanks. The Oilfield Services, the EBITDA this quarter, very good perhaps. But is that sort of like a base -- I forget, is there seasonality in there? Is that like a base EBITDA level we could see for the quarters sequentially from here?

Ian Cleminson -- Executive Vice President & Chief Financial Officer

Yeah, Chris. One of the things we've been talking about in our oilfield specialties business for a while now is the need to improve the underlying profitability. So, there is a feeling that we are hitting EBITDA margins of round about 10% as we exit the year and our operating margins are in that sort of mid-single digits, so 5.5%, 6%.

Our aim is to move the operating margins to around 10%, and we're partway there. We exit the year in good shape, probably around about 7.5% in the fourth quarter, about 5.5% for the full year. So, there is work to do here. And part of that is the way the market has gone in the last couple of years. And part of it is down to -- generally, pricing from competitors needs to improve and we need to be mindful of our profitability and our own pricing. So, lots of work to do. Very pleased with where we've got the business to. Fantastic year-over-year growth. But we're not sitting back, we want to go again in 2019.

Christopher Shaw -- Monness, Crespi, Hardt & Co. -- Analyst

But there's nothing seasonally strong about the fourth quarter in genera? That's a sort of kind of more normal number, hopefully, if you can get the margins up?

Patrick Williams -- President and Chief Executive Officer

Yeah. Nothing seasonal in the fourth quarter. Typically, what you see is, if you have a strong Q4, you'll drop off a little bit in Q1. But we really have not seen that at all.

Christopher Shaw -- Monness, Crespi, Hardt & Co. -- Analyst

Okay. Interesting. And on the Fuel Specialties side, was any of that strength -- you've often talked about in the past. I know it was pretty cold in North America, at least where I was. Was there any of the cold flow product? Is that some of the boost in volume or the strong --?

Patrick Williams -- President and Chief Executive Officer

Yeah. A lot of that is product mix. You're exactly right. Some of that is product mix. So, a lot of the CFI in cold weather areas definitely helped that enhancement in growth.

Christopher Shaw -- Monness, Crespi, Hardt & Co. -- Analyst

I know people have asked periodically, but on the IMO 2020 stuff, I feel like you were getting inquiries in the past. Are there real orders out there for products at this point or is it still wait and see --?

Patrick Williams -- President and Chief Executive Officer

There's orders out there. I think there's still a lot of unknown as to where it's actually being treated. It's going to be treated at the refinery, at the pipeline or on the vessel. So, there still is a lot of unknowns out there. Obviously, there's a lot of scrubber technology out, et cetera. But we're following the market, we're in the market, we're selling products in the market. To the magnitude of how large a revenue potential it's going to be, we just don't know until we know what point of application is going to be.

Christopher Shaw -- Monness, Crespi, Hardt & Co. -- Analyst

Got it. And if I can just end with the question on the M&A. You mentioned it briefly in the write-up. But I think you haven't done a deal in a little bit of a time, which is a bit rare for you. And the balance sheet is obviously quite good. So, any thoughts there on what the pipeline looks like?

Patrick Williams -- President and Chief Executive Officer

Yeah. I'll tie a few things. One of the things that we want to do is have the proper working capital for organic growth because, obviously, it's your cheapest growth because you're not putting a multiple on it. And we have great projects internally that we're focusing on right now. Hence why we haven't gone on, done a big deal.

The other reason why, as you've seen on the market, multiples have been extremely high and we're not going to chase multiples just to chase revenue. It's not the way we operate. So, I think, for us, it's balancing that program to really look at increasing our dividend, which we've done every year. And the likelihood is we're going to do that again. We'll focus on the organic growth projects that we have internally and we continue to look in the market for M&A that really fit our portfolio. And if the right thing comes along, you'll see us come out the market and do something. But as of right now, multiples are extremely high. And the perfect deal, which there's never the perfect deal out there, but the right deal for our company is not there quite yet.

Christopher Shaw -- Monness, Crespi, Hardt & Co. -- Analyst

I agree. Thanks for the input.

Patrick Williams -- President and Chief Executive Officer

Thank you.

Operator

Thank you. Your next question comes from Jon Tanwanteng from CJS Securities. Please go ahead, sir.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Actually, my question was answered. Thank you very much.

David Jones -- Vice President, General Counsel and Chief Compliance Officer and Corporate Secretary

Thanks, Jon.

Operator

Thank you. There are no further questions at this time.

(Operator Instructions)

Patrick Williams -- President and Chief Executive Officer

We can go ahead and conclude.

Operator

Thank you very much. There are no further questions at this time. That does conclude our conference for today. Thank you very much for participating. You may all disconnect.

Duration: 28 minutes

Call participants:

David Jones -- Vice President, General Counsel and Chief Compliance Officer and Corporate Secretary

Patrick Williams -- President and Chief Executive Officer

Ian Cleminson -- Executive Vice President & Chief Financial Officer

Jonathan Tanwanteng -- CJS Securities -- Analyst

Curt Siegmeyer -- KeyBanc Capital Markets -- Analyst

Christopher Shaw -- Monness, Crespi, Hardt & Co. -- Analyst

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