Innospec Inc
NASDAQ:IOSP
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Innospec Inc
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Ladies and gentlemen, thank you for standing by. Welcome to today's Innospec's Second Quarter 2020 Earnings Release Conference Call. At this time, all participants are in listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I also must advise you this conference is being recorded today, 5th of August 2020.
I now hand you over to your first speaker, David Jones.
Hello. Welcome to Innospec's second quarter earnings call. Today's call is being recorded. I'm David Jones, Innospec's General Counsel and Chief Compliance Officer. The earnings release and this presentation are posted on the company's website at innospecinc.com and will be available on the site for at least six months.
During this call, we will be making 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 risks and uncertainties. These statements involve a number of risks, uncertainties and assumptions, including the effects of COVID-19, such as its duration, its long-term economic impact, measures taken by government authorities to address it in the manner at which the pandemic may exacerbate other risks and uncertainties that could cause actual results to differ materially from the anticipated results implied by forward-looking statements. These risks and uncertainties are detailed in Innospec's 10-Q, 10-K and other filings with the SEC. Please see the SEC website or Innospec's site for these and other documents.
In our discussion today, we've also included 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 Innospec's site. They are included as additional clarifying items to aid investors in further understanding the company's second quarter performance in addition to the impact these items and events have on the financial results.
Also with me 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.
Thank you, David, and welcome, everyone, to Innospec's second quarter 2020 conference call. This has been an extraordinary quarter, not just for Innospec, but for most companies in our respective industries. The combined impact of the COVID-19 pandemic and the demand destruction in the crude oil markets has been well documented.
Against this background, Performance Chemicals had an excellent quarter. Our team have dealt with interruption to production of products early in the quarter and a very volatile demand patterns from our consumer goods customers. Delivering an 11% improvement in operating income is a significant achievement and strengthens our confidence in the future of this business and its rising profitability.
Fuel Specialties experienced a very difficult quarter as fuel demand collapsed. Passenger car miles were impacted by the lockdowns around the world and the reduction in global trade was reflected directly in reduced freight transport. With air travel directly affected, demand for both jet fuel and aviation gasoline was minimal.
Customers also reduced inventory to conserve cash, and therefore, demand for additives was off significantly, resulting in our Fuel Specialties revenues being down 19%. We do expect the business to recover in line with returning economic growth.
The second quarter of 2020 saw crude oil prices briefly invert for the first time in history, as supply exceeded demand and storage was at record levels. This net effect with the exploration and production companies cut capital projects in drilling and completion while reducing production in some locations.
In turn, although we have not lost market share, our revenues have been badly impacted and sales down significantly. We have responded by cutting cost and rightsizing our organization to meet near-term conditions. Our strategy to reduce the cyclicality of this business remains on track as our sales into production and stimulation to the Middle East have increased.
Despite the reduction in the pipeline throughput, we are very pleased with our progress in drag-reducing agents. In fact, we have now secured significant impacted sales to sanction the second phase of capacity expansion at our Texas plant.
Now I will turn the call over to Ian Cleminson, who will review our financial results in more detail, then I will return with some concluding comments. After that, we will take your questions. Ian?
Thank you, Patrick. Turning to slide eight in the presentation. The company's total revenues for the second quarter were $244.9 million, a 32% decrease from $362.4 million a year ago.
The overall gross margin decreased 6.6 percentage points from last year to 24.1%, driven mainly by reductions in both Oilfield Services and Fuel Specialties, somewhat offset by a further margin improvement in Performance Chemicals.
It's worth noting that our results also include a restructuring charge of $21.1 million to reflect the long-expected cessation of the Octane Additives business, of which broadly half the charge is non-cash.
We also took a non-cash impairment charge of $19.8 million, relating to intangible drilling assets in oilfield services. EBITDA for the quarter after the restructuring charge of $21.1 million was a loss of $19.5 million compared to an EBITDA of $43.8 million last year.
Our GAAP loss per share was $1.62, including specialty effects, the net effect of which decreased our second quarter earnings by $1.44 per share. A year ago, we reported GAAP earnings per share of $0.90, which included an adverse impact from special items of $0.22. Excluding special items in both years, our adjusted loss per share for the quarter was $0.18 compared to an adjusted earnings per share of $1.12 a year ago.
Moving on to slide nine. Fuel Specialties results for the quarter reflected the low demand for fuel. Revenues were $107.4 million, down by 19% from last year, driven by a 15% reduction in volumes, combined with an adverse price/mix of 3% and a negative currency impact of 1%.
Gross margins were 23.6%, down significantly on last year's second quarter. However, this included an inventory adjustment of $8.2 million. Without this charge, the adjusted gross margin would have been 31.3%, which is just on the low side of our normal range.
This resulted in operating income of $4.7 million compared to $24.1 million a year ago. Our expectation is that demand in Fuel Specialties will start to improve during the third quarter.
Turning to slide 10. Revenues in Performance Chemicals for the second quarter were $95.7 million, down 9% from $104.7 million a year ago, with 4% lower volumes and adverse price mix of 4% and a negative currency impact of 1%.
We've continued to improve our gross margins through a better sales mix and raw material improvements, driving margins up 3.1 percentage points from last year. Operating income was up an impressive 11% from the second quarter of 2019 to $12.2 million. Our expectations are that this business will continue to perform at this level in the third quarter.
Moving on to slide 11. Oilfield Services revenues of $41.8 million were down by 66% on the same period last year, reflecting the reduction in customer activity in the U.S. onshore markets in drilling, commission and production. Gross margins were down significantly to 23.7%.
However, this included inventory adjustments of $4.7 million. And without these adjustments, gross margins would have been at 34.9%, 1 percentage point higher than the same period last year. In response to the changing market conditions, we have reduced our cost base by $9.1 million year-over-year, as we have right-sized the business.
The operating loss of $12.4 million for the quarter compared to an operating income of $10.1 million in the same period last year, and we see Q2 as the low point for this business. We have recognized the changes in the drilling in the oil and gas business and taking a non-cash impairment charge of $19.8 million to reflect the value of intangible assets.
Moving on to slide 12. In Octane Additives, as expected, there were no revenues in the quarter compared to $1.9 million a year ago. The operating loss of $1.6 million compared to an operating income of $0.1 million in last year's second quarter.
We have determined that there will be no further orders for motor gasoline, and therefore, the Octane Additives business has ceased. As a result of this, we have booked a restructuring charge of $21.1 million.
Turning to slide 13. Corporate costs for the quarter were $15.4 million compared to $13.6 million recorded a year ago, driven by higher personnel and IT-related costs. The effective tax rate for the quarter was 26.2% compared to 26.9% last year.
Moving on to slide 14. Given the extraordinary trading conditions, net cash provided by operating activities in the quarter was excellent at $29.8 million compared to $50 million a year ago. In the quarter, the company also distributed $12.8 million to shareholders for the semi-annual dividend.
As of June 30, Innospec had $58.2 million in cash and cash equivalents and total debt of $39.6 million, resulting in a net cash position of $18.6 million. We also have substantial liquidity headroom.
And now I'll turn it back over to Patrick for some final comments.
Thanks, Ian. As we move away from COVID-induced impacts in the second quarter, our focus is to execute on the substantial growth opportunities which exist in all three of our business units.
Performance Chemicals has continued to deliver improved margins and has a great future. The consumer trends emerging from the pandemic will generate additional growth prospects and we have a number of organic and acquisitive opportunities to enhance this business.
As the economy recovers, so will fuel use and Fuel Specialties growth will return. The shape of this recovery is yet to be determined. But we expect more normal demand to return in the near term. We will continue to drive our diversification strategy in Oilfield Services.
As previously stated, we are delighted with customer response to the performance of our new drag-reducing agents and the resulting sales contracts have allowed us to invest in further capacity.
Sales into Europe, the Middle East and Africa, are still small, but we are encouraged by the growth and the technical performance of the products in a number of countries.
We are in a net cash position, reflecting a strong balance sheet driven by our conservative cash management policies. With significant borrowing headroom, liquidity is not an issue. This positions us well for our many organic growth projects and also for strategic acquisition opportunities.
Now I will turn the call over to the operator, and Ian and I will take your questions.
[Operator Instructions] We'll now take your first question. It's coming from the line of David Silver from CL King Capital. Please go ahead. Your line is now open.
Yeah, hi. Thank you. Good morning.
Morning, David.
Good morning. So a couple of questions. I mean, first, maybe just a clarification on the term inventory adjustment. So Ian, you, I think for two of the three segments, you cited inventory adjustments that were part of the reduction in operating income this quarter.
And I apologize, but when you use the term adjustment, are you writing off? Is that to reflect the write-off of obsolete inventory? Or merely to write down the expected value like a lower of cost to market adjustments, so just product is still commercially viable but the selling price or the profitability is not what it was in a more robust energy price environment? Thank you.
Yeah, a little bit of both, David. In Fuel Specialties, we took a hard look given the downturn in demand. There's some obsolescence in there from inventory that's no longer required by our customers. There is some raw material adjustments because raw material pricing has come down.
And there's also some aged inventory as well. There's very little inventory that we think that we won't be able to sell at some point in the future, but we've taken a very prudent view of the market, and we've been very cautious in what we've done.
In Oilfield, the - just $4.7 million adjustment there, like a lot of other people, demand has collapsed in Oilfield, and we've - that started us to take a really hard look at our inventory. And most of that is inventory. We feel like it's going to be difficult to sell in the future. So we've written it down, and we'll see what happens as demand comes back. And if we can sell it in the future, we absolutely will.
Okay. Thank you for that. And then my next question would be about the Oilfield Services business. So Patrick, I think 1 quarter ago, you spoke at some detail about kind of managing that particular business for an environment of lower oil prices. And I'm going to misquote you, but you kind of talked about it may be more surgically or making cuts with a scalpel to ensure that the business had the capability to respond quickly to a return of business.
So a couple of questions, but I'm just wondering in your view, has the pace or your expectations for recovery in that business changed since three months ago? And if so, I mean, is it because the industry is not responding to particular oil price points?
Or is it something to do with the financial capabilities or the financial resources in the industry? Just maybe how has your view of what rightsizing or aligning the Oilfield Services business on the current environment, how has that maybe changed from March 31 to today? Thank you.
Yeah, good question, David. We took about 210 individuals that were either laid off or furloughed. We have about a cost savings of about $9 million. And we still feel like we're okay with where we are today in regards to the business. The one thing we don't want to do is dismantle the business for the current customer base that we have. And we haven't lost any business. It's just obviously, there's a lot of cutback in CapEx, et cetera, and capital spend.
So we're confident the business is going to come back. We're already starting to see that into the third quarter in the stimulation and production side as well as the DRA side. And so I think what we had to see early on through Q1 and early on through Q2 and will last obviously through Q3, is that there's not been a lot of capital deployed into the oil and gas markets, not the flavor of Wall Street, it's not the flavor of private equity.
And obviously, for E&P companies sitting in this market today, they have to figure out where they can cut as well. And so a lot of their capital projects have been delayed. So we are starting to see some capital being released. We're starting to see rigs ramp up a little bit and stimulation crews coming back.
It's going to be a slow process and a slow recovery. But we feel that demand will start coming back. Supply has been cut significantly because all the production shut in and not a lot of wells drilling right now. So you're starting to see oil prices creep back up. I think you're starting to see the proper behavior across the globe in regards to supply, demand and pricing.
And so it's an unhealthy business globally for anybody. And I think we're in the best position if we control our cost and we continue to provide great technical and performing products, we'll be in a great position for the recovery. But we have done the necessary things to take care of the business short term. And I think we're properly positioned.
Okay. Thank you for that. And then maybe one last one on the DRA expansion. So if I have this right, I mean, your initial plant for DRA production, you were able to sell out, let's say, in less than a year or maybe about a year or a little less.
And can you remind me just maybe as a multiple, I mean, how much bigger or how much greater will your capacity be following this current expansion, three time, two times, whatever. And then what is your expectation for the timetable to completely fill out or allocate this next stage of production capacity for DRAs? Thank you.
Sure. Good question, David. The neat thing about this business and almost all of our assets across all of our businesses is that we don't have an enormous amount of large assets that cause a lot of large CapEx. So to double capacity in DRA was a fairly insignificant number. And so we are doubling capacity and the doubling of capacity is almost sold out as well.
So in the near term, after we see that double capacity is sold out, the markets are starting to come back, demand is coming back, we will actually go into another capacity expansion. So we feel pretty confident that our technology is providing us a nice avenue of future revenue and the ability to expand in the proper way and not put too much volume on the market.
Additionally, what we're doing, Dave, is we're looking at heavy crude oil right now and a new technology for heavy crude. We're also looking at a technology for fuels. And the technology we have right now is for light crude oil. We are expanding into other markets with new technology.
We'll have trials going on there, sometime in the near future, and that will help the ability to expand even more as well. In addition to that, just to give you a quick update on DRA because you might ask the question, here in the near term, we should have a few trials going on in the Middle East, specifically in Saudi Aramco, which we should hope and from what we're seeing from the performance of our products, should bode well for us.
So we're feeling pretty confident in this business that even in the environment we're in today, we're sold out. And you'll start seeing that reflect in our numbers probably sometime in Q3, and you'll see a better reflection in Q4 and Q1 of next year.
Thank you. And then just one last one, just to clarify on the - one of your DRA comments. So you mentioned a DRA product customized, I guess, for fuels as opposed to crude oil.
Correct.
Is that common? I mean, I'm not a - people have talked about that as a late - next development or a later stage development. But would Innospec be the first with a DRA product for something other than crude oil or from the wellhead type of production?
No, the fuel is a very big market. And the same players that are in the light crude oil market are also in the fuels market. Now it's not as big as crude, but it's a strong market. And we have a technology we think that fits that market well.
So it's a mature market. The other markets we're looking at heavy crude oil. But no, its fuels is already there, and it's just a function of putting the proper product in that market.
Okay, great. Thanks for all that. I'll take off here. Appreciate it.
Thank you. Next question comes from the line of Jon Tanwanteng from CJS Securities. Please go ahead. Your line is now open.
Good morning. Thank you for taking my questions. My first one, I might have missed it. What is the - can you re-quantify the inventory charges you took in both fuels and oilfield and kind of what the adjusted operating margin would have been without them?
Yeah. So Jon, we took $8.2 million charge in Fuel Specialties. And that would have moved our gross margins up to 33%, which is just at the lower end of our normal range there, Jon.
And within Oilfield, we would - we took $4.7 million of inventory charge, and that would have moved our gross margins just about 1 percentage point higher than they were this time last year.
Okay. And as we think of Q3, is that the right base to use those adjusted operating margins? And I assume there's no - not going to be charges going forward.
Yes, I think that's a good point, Jon. And we certainly believe that within Fuel Specialties, we've taken all the inventory charges that we need to, and we've set that business on the right path for Q3. And certainly, as we look at July, our gross margins are in the right range and back to where we'd normally expect them to be.
Oilfield, I think that will - very much, that will depend on how the recovery comes. But we've certainly done everything we needed to do in the second quarter, but we'll keep an eye on that. But again, I think you're going to see those gross margins in that sort of low 30s, where they would normally be within both those businesses.
Got it. That makes sense. And then just on the Oilfield business, can you be EBITDA profitable at current energy price levels in the next 2 quarters? Or is there still some ground to make up in terms of both price and volume?
Yes. I'll take a little bit of that first, and Ian, if you want to comment. I think that we can get EBITDA neutral in Q3, and I think you'll see OI positive in Q4.
I think that's fair. I think that's certainly the direction of treble we're heading in, Jon. And if we get some movement on the top line, which we're starting to see a little bit of with the cost savings that we've made and some other adjustments in the business, I think that's certainly the ambition and directly, and that's where we're heading.
Got it. That makes sense. And then finally, just on the corporate cost. Can you give a little bit more color on what drove the higher expense sequentially? I think you've mentioned personnel, but maybe just more detail on that, number one. And number two, how you see SAR as a run rate, given the restructuring and cost reductions you've taken going forward?
Yes. So on the corporate cost, as you remember, Jon, this time last year, we were in the midst of a cybersecurity incident. And what we've done is that we've actually taken a hard look at the business, and we've increased the capabilities and the capacities of our IT function. And that's most of the increases from that, both in spend of IT but also in headcount around IT. So that takes most of that change.
And then in terms of the SG&A, as we said earlier on, we've made adjustments in Oilfield. We don't think we need to make any further adjustments there for the time being. We don't need to make any adjustments in Fuels or Performance Chemicals for the time being.
So I think that $9 million of where we are in the quarter, maybe even a little bit more the full quarters, you'd probably see on an annualized basis, probably about $35 million to $40 million lighter than we would have been at the start of the year.
Got it. That's helpful. And then sorry, finally, you're sitting on a very pristine balance sheet, nice job on cash flow. Any updates on capital allocation, particularly on buybacks, but also M&A and how you think of dividends at this point?
Yes. I think it remains the same, Jon, is that we're going to follow the share price. And I think we're reserving capital right now for M&A because we're starting to see some of the multiples come down in areas of focus. And so our primary use of capital will be organic growth, because that's our cheapest and most profitable growth. And we have numerous projects into Q4 that.
Secondly, will be to make sure we balance out the dividend with M&A activity. And our view is to keep the dividend. We'd like to see the dividend increase. We just want to be market responsible and make sure that the markets are coming back to somewhat some face of normality before we increase that dividend going into the final quarter.
But I think the M&A activity is a primary focus for us in some of the areas that we know have a great future and a bright future for us, and we're seeing some fair multiples out there right now on businesses that have made sense for us for quite some time.
Got it. Thanks for that color, guys.
Thank you.
Thanks, Jon.
We have no further questions coming from the phone lines. Please continue here.
Thank you all for joining today, and thanks to all our shareholders, customers and Innospec's 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 being up with you again to discuss our Q3 2020 results in November. Have a great day and stay safe.
Ladies and gentlemen, this does conclude our conference call for today. Thank you for participating. You may now disconnect.