Innospec Inc (IOSP) 2003 Q3 法說會逐字稿

Please stand by. We're about to begin. Good day and welcome the Octel Corp. third quarter 2003 financial results conference call. Today's call is being recorded. Certain statements made herein constitute as forward-looking statements that involve risks and uncertainties, including risks associated with a business plan that affect and - the affects of changing economic and competitive conditions and government regulations. Additional information may be obtained by reviewing the company's report filed from time to time with the Securities and Exchange Commission.

With us today from the company is President and Chief Executive Officer, Mr. Dennis Kerrison, and the Chief Financial Officer, Mr. Paul Jennings. At this time, I would like to turn the call over to Mr. Dennis Kerrison. Please go ahead, sir.

Thank you, , and good morning, everyone. Welcome to Octel Corp.'s third quarter shareholder and analyst call. As is our usual practice, Paul Jennings, our CFO, will start this morning's conference call with a review and analysis of the financials and highlight the key points of the quarter and the year to date. These are the results that were issued last evening.

Following Paul's comments, I'll make a few business points regarding trends and direction. I'm pleased to say that we are delivering performance in TEL and our specialty chemical division is starting to meet our expectations. After a short summary, we will be pleased to open up for questions and comments. Now I'd like to pass you over to our CFO Paul Jennings.

Thank you, Dennis. Good morning, everyone. I'm Paul Jennings and I'm very pleased to be able to present the financial information for the third quarter and the first nine months of 2003 for Octel Corp. The quarter has continued the progress outlined earlier this year in our specialty chemicals business and TEL has had a particularly good quarter.

Specialty chemical operating income was over 27% higher than last year for the quarter and is now over 8% above last year for the nine-month period. Ongoing TEL income was well above the same quarter last year, helped by a relatively normal quarter of deliveries and some acceleration of deliveries expected in quarter four into three at the request of customers. In additional, a number of restructuring charges were incurred in line with FAS-146. Net income for the third quarter of 2003 was $18.4 million or $1.47 per diluted share compared with a profit of 18.3 million or $1.44 per diluted share in the comparable period last year.

For the nine months, net income is 38.9 million or $3.11 per diluted share, compared with a profit of 54.4 million or $4.32 per diluted share in the same period last year. This is after taking a 59 cents per diluted share after tax charge for restructuring.

Looking at the performance by strategic business units or SBU, specialty chemicals had another good quarter with sales of $46.9 million, a 3.1% increase over the very strong quarter last year. 2002 numbers have been adjusted to reflect the closure of the loss making Asian business highlighted in last quarter's results. Gross profit for the quarter of $15.9 million was 12% ahead of last year, reflecting the improved activity and the now ongoing benefits from the restructuring activities.

Year to date sales of $141.9 million are 11.5% up on last year, with gross profit 7.1% higher at $46.8 million. The acquisition integration process is now essentially complete and we are benefiting from an improvement in operating performance as a result. The completion of this process will be more fully apparent in 2004.

Moving onto TEL, we had an excellent quarter with the resumption of more normal sales pattern. Sales were $76.4 million for the third quarter, 15.2% above the same period last year. Selling prices continue to be well managed and have reduced the impact of the global market volume decline. Gross profit improved to 53% of sales or $40.5 million for the quarter. Year to date sales of $192.4 million are now 1.9% above last year's levels, despite volumes being 14.6% down, reflecting the selling price management mentioned earlier.

The quarter was also favorably impacted by some acceleration of deliveries at customer request. Operating expenses, excluding restructuring costs of $64.4 million for the year to date are running around 10% above last year's levels. The increasing weakness of the U.S. dollar has had a mild impact on these costs as the bulk of our operating expenses are based in currencies other than the U.S. dollar. Over the equivalent time period for 2002 and 2003, the dollar is, on average, 9.6% weaker, accounting for almost all of the year over year increase.

In addition, in quarter three, there were real reductions in cost in the specialty chemicals business, offset by a increase in pension accruals. Provisions for restructuring costs of a further $2.3 million were make in the third quarter of 2003, relating primarily to the previously announced restructuring of our Ellesmere Port site. After tax, these amounted to 13 cents per share for the quarter.

We have delayed the TEL downsizing originally planned for early 2004 until later next year in order to be able to meet current demand. It is now expected that aggregate further charges will sell to around $10 million during the remainder of 2003 and 2004, principally in the TEL operation. This treatment reflects the implementation of FAS-146 on the recent restructuring programs. The combined restructuring charges reflect our well-known objectives of rationalizing sites and assets to capture synergies in specialty chemicals and also being proactive in managing the continuing decline in demand for TEL.

As mentioned last quarter, we continued to monitor the value of TEL goodwill on a quarterly basis in line with FAS-142. And at the present time, we see that 2004 will be the first year we will have to take a non-cash charge in the TEL operation. This position will be further reviewed at year-end. Cash flow from operating activities was strong at $38.8 million for the third quarter of 2003, bringing the year to date to a $56 million cash inflow. For the nine months, investing activities consumed $14.1 million of cash, the remaining payments under the provisions of previous acquisitions, the conclusion of the very TEL agreement and the closure and sale to two small non-core business which were identified last quarter.

As mentioned last quarter, we initiated a review of our debt structure due to external advisors with a view to strengthening the long-term liquidity of the company. We have made presentations to a small number of select banks and we are currently evaluating their proposals. The response has been very promising. Given the proximity of the holiday period, we expect that this process will now be concluded in early January, well in advance of the October 2004 renewal date.

The falling out gearing ratio of net debt to debt plus equity continues and it is now below 20%. Interest costs were high in the quarter compared to last year's abnormally low third quarter, which had included accrual adjustments from previous quarters. The implementation of FAS-143, which now requires a notional interest charge to be made on remediation provisions and the accelerated amortization of bank fees impacted this year's charge, both of which are non-cash items.

Our effective tax rate was 32% for the quarter, higher than the same quarter last year, but more in line with the final full-year rate for 2002. Year to date, our effective task rate is 31%, reflecting the mix of profits earned in the business and the timing of restructuring payments. In addition, the company reimplemented the share buyback program during the quarter in line with our announcement during the middle of August.

In summary, specialty chemicals continued to make improvements year over year, with a benefit to restructuring now fully apparent. TEL had an excellent quarter following the resumption of more normal shipment levels and cash generation was strong. Thank you for your attention and support and I will now hand you back to Dennis Kerrison for his report on the business.

Thank you, Paul. As Paul has outlined the business reasons underlying the numbers in some detail, I will restrict my remarks to the impact on the company presently and going forward. A more detailed overview will be given in the full-year results in February. I feel this is particularly appropriate for a company like Octel, with TEL in continuing decline. The measure in strategy and quarter-on-quarter results have to be taken, as you are aware, within this context.

Let me start with our specialty chemical businesses. While our specialty chemical businesses are complex, we are, as I'm sure you are aware, undergoing an inspiration, restructuring and growth program. I am please to say we are making excellent progress on all fronts. We are now starting to deliver on our pledge of acceptable profitability and growth. Our 8.4% year-on-year improvement in operating profit is evidence of the success of that integration and rationalization program in the fuel additives air petroleum specialties - substantially, our largest specialty business.

We are structuring for growth by rationalizing optimizing product ranges, our sales operation and routes to market. This is in addition to the manufacturing rationalization and admin reductions . In petroleum specialties, our year-on-year improvement in profitability is significantly better. So this is partially offset by poor profitability of our detergent additive business Europe, which is explained at the end of 2002.

Product range, however, has just won a UK war for environmental green technology and we have great hopes for the future in niche markets. While these results are now visible and encouraging, there's more to be done. I would repeat what I said of year-end 2002, mainly that we would make significant progress in specialties in 2003, but with the full effect being seen in 2004. The lack of critical in performance chemicals continues to be of some concern and our corporate development team continues to look for suitable and sensible acquisitions to balance our portfolio and accelerate our growth.

The TEL business, you will recall, had a very difficult start with the unforecastable problems in Venezuela and Middle East, particularly Iraq. I would like to reiterate the points I made at the end of the first quarter. Our staff has made excellent progress under the least promising conditions imaginable. Process in the systems no longer exist in these countries and also, in some cases, certain no longer existed. To deliver the results, we have, under such circumstances, performance of the highest order.

In particular, to be delivering profits in the balance of the previous year, reflected by the 53% gross margin in the quarter, this has, in fact, given us problems, albeit happy ones. During the next quarter, we will be amending our operation schedules to optimize the next TEL plant downsizing. This is likely to be six to nine months later than previously anticipated. We need to evaluate further the impacts on working capital stock, cash and profit optimization.

All in all, a very satisfactory performance. While we are confident we can continue to deliver in the fourth quarter, we will continue to manage and understand our responsibilities in the strategic and sensible use of our excellent cash flow profile from the TEL business. Thank you.

At this stage, I'd like to throw the discussion over for questions or comments that any of you have for Paul and myself. We'll try to answer as many as we can. If we need to refer, we'll come back to you on any points. OK?

Thank you. Today's question-and-answer session will be conducted electronically. If you would like to ask a question, you can do so by simply pressing the star key followed by the digit one on your touch-tone phone.

Once again, that is star, one. Do keep in mind, if you are using a speakerphone, please make sure your mute function has been turned off to allow your signal to reach our equipment. We will take the questions in the order you signal us and take as many questions as time permits. We will pause for just a moment.

And we will take our first question from from .

Actually, this is sitting with at 's desk. Dennis and Paul, congratulations to you on a wonderful report. I repeat the same question I think I've expressed to you from time to time about the attraction of further purchase of your shares versus further acquisition. It seems to me that the shares would be more attractive even recognizing your need to perhaps round out your acquisition portfolio until such time as they move up significantly, at which time the shares might be a more attractive currently to use.

, it's good to hear from you. Thanks for those comments. Just as you are asking the same question we give you the same answer. But it's a very good question. The point I made then and I'll pass it over to Paul to tell you that - what we're actually doing. We are not chasing acquisitions per se. We do see a weakness through lack of critical mass. And I think I said sensible and affordable among our acquisitions. We're not going to do anything crazy and we do understand and actually agree with you in terms of the value of our stock. Paul, do you want to ...

Sure, , this is Paul Jennings. The other thing that, at the moment, as you know, we did actually restart our buyback program back in August. And as you can see from the cash flow, I think we spent about a million dollars of that through the end of quarter three since that period in August. We're also in the process of undertaking a - the refinancing of our debt structure with our banks and we're likely to conclude that, probably around the end of this year or maybe into January.

And so, what we're trying to do is to try and follow a balanced program whereby we do repurchase stock, we do provide dividends to our shareholders, we do make some acquisitions and reinvest in the business. And I think, really, it's just balancing that timing for this particular stage, but we have reinitiated it and, as you know, I mean, our stock is not a very liquid stock and so it's - we only, you know, can purchase a certain number of share at a particular time. But we have been able to do some of that in quarter three, which we're pleased about and it's certainly part of our ongoing strategy for the business.

Is it your objective to eliminate the bank debt, ultimately, or would you continue with, say, 20 or 25% of your capitalization in long-term obligations?

I think, - again, this is Paul. I think, at this particular stage, as you know, our existing bank debt expires at the end of October next year with our balloon payments. And I think that, you know, given the strength of the cash flows that we've got for the business, I think we can actually have some bank debt. But I'd want that to be on a more - on a longer-term basis so that we're not having to make any knee-jerk reactions to anything. And then we can use the cash that we generate in the business to pay that down over time. But also to use it for the other things that I've mentioned earlier on. I think that would, then, you know, anybody looking at the business sees that we have a much more sustainable one-term liquidity position, which I think is really important to the company and the shareholders as well.

Thank you, sir.

And as a reminder, that is star, one to ask your question. And we will now move to .

How are you doing, guys? I was wondering, on the operating income, you have about - and especially chemical business - about a 6.3%. And I was wondering what could you guys get that up to over time with the restructurings.

OK. Let me start and Paul can add to that, . Go back to what we said historically that we believe that a steady state of normal specialty chemicals should be making between 10-15% operating profit return on sales. It would change, depending on the economic cycle - obviously, competition, new technology, integration of acquisitions, et cetera. We - I'm not sure if you're aware of this. We started in '97, '98 with a loss making business when we spun out at Great Lakes and we built it up to double-digit return on sales. We got into the integration. Now with these acquisitions, we've slipped back a bit because of costs we have to take out and people we're going to have to take out. We see no reason why we shouldn't be back at double digit in the not too distant future.

, if I could just answer that from Dennis. This is Paul. We - in the quarter, we were at just shy of 8% operating income in the business. And that's - and that's where we really started to see some of the benefits of the restructuring, which aren't fully apparent in the 2003 results. But I think Dennis' comments around 10% plus for those business are highly doable for this - for that particular area of the company.

So if I'm looking at it on a 2004 basis or a 12-month run rate, I should - I could look at it at, let's say, 10% - 10-15 next year. Or is this something we're looking at 2005, 2006?

Well, don't, obviously, can't make a forecast, but there's no reason. It depends on when you take it full year. So that one will take about a year. But we will be - sometime next year we'll be at a run rate about 10. Fifteen depends on a lot of things. It depends on more material movements. It depends on economic activity, et cetera. But certainly, hitting that 10 is something which is achievable in the not too distant future.

OK. Thanks, guys. Good job.

Thank you.

And as a reminder, once again, that is star, one to ask your question. And we will take our next question from with Smith Barney.

Good morning, guys.

Good morning.

Good morning, .

Just a couple questions. A follow-up for 's question on share buyback. Do you have any schedule for the money you have left in the old program to buy back, for when you think you'll have that bought by or does it - does it depend on when you're loosened up with the refinancing, to kind of melt that in so you don't feel pressed on other things?

, this is Paul. We, you know, we did do some share buybacks and actually stop them during the middle of last week. And we're start them as soon as practically possible. And we will be continuing to buy back at levels that we're allowed to do under the regulations. We obviously, we have a debt repayment that we have to make in December, as I previously mentioned. And we will be refinancing the business around the end of December or early January. So it's likely that we - it will probably be a little bit slower over the next quarter and then we'll reevaluate it once we've got the long-term financing in place.

OK. And in your press release, you mentioned that you borrowed a little bit of business on TEL from the fourth quarter from your customer's request. Could you tell us about how much you think you took out of the fourth quarter?

I can't comment specifically on the absolute amounts, but there were a number of customers that we were expecting to take to delivery in quarter four, but they accelerated - I mean, to quarter three - as we get closer to the year-end and price changes and various other things. As, as you know, the TEL business is actually quite lumpy anyway from a quarter to quarter basis. But there was, you know, some volume and - that was brought forward into Q4, so we're not expecting those levels in Q4 to be at the same level as Q3.

OK. And do you think you'll lose any customers in '04? Do you look for the TEL to stay on a 15% decline projection or do you think those customers will stay? In the past, it looked like you weren't going to lose anybody until 2005.

Well, let me address that, just in count. We're losing small customers over time as people roll out. But it's true to say we don't - we won't lose any in quarter four. And next year, it's not expected that any of the big boys will exit. Obviously, some of them are running down and there are deadlines, which we've discussed before. So I think that 15% this year is fine. And we should have a reasonable year next year. I don't want to go too much further than that because we specifics and it is a very lumpy business, though, as you know.

OK. Could you talk a little bit about specialty chemical growth for what you see over next year and the year after?

In terms of the - in terms of the business - and the biggest run, of course, is the petroleum specialty business. A lot of the growth we're getting is coming from the rationalization program and streamlining the business. And it's not just cutting back and taking costs out. It's actually streamlining the business and making it more effective on a global basis. We will see the full-year effects of that in 2004. So there will be some substantial growth over 2003.

And then, looking forward, you'd say, well, what's the reason the Octel should grow any more than the market? I think there are a couple of reasons. One is new technology because there's a lot of regulations and standards coming out around the world, particularly in the U.S. and the EC, which demand new technologies. So there will be growth in new areas - cleaner diesel, cleaner gasoline, less emission type of things. So there are going to be opportunities there.

Also, we are particularly good in, if you like, the non-traditional markets - the Asia Pacific areas where you've got countries with their own refineries, where we've got very long-term relationships. And they're growing there as well. So we see good growth going next year. We see healthy growth the following year. And then after that, it depends how the new technology comes in.

All right. And this was really a very nice quarter. Can you guarantee us another 100 quarters like that?

Yes, I can, little boy. My name is Santa Claus.

Thank you. Very nice quarter.

Thank you, .

And now we will take a question from with Capital .

Actually, I have a few questions here. The 56 million of cash flow - is that pretty much also proxy for free cash flow so far this year?

Yes.

And can you give us some sense of a - perhaps, a first cut at next year now that we're, you know, that close to it? Are we - are we kind of looking at the same band again of somewhere kind of in the 55, 65 kind of range?

Well, I mean, as Dennis just said earlier, I mean, obviously, we don't give any sort of projections for future quarters or years, but, you know, we do see within TEL, we're looking at the sort of 15% on decline, which we've seen in previous years. We will be looking to, you know, to make sure that we invest wisely in other areas and looking at areas where we can improve working capital. But at this stage, you know, we still - we still expect to see that declining TEL going into 2004.

I guess what probably people want to get some kind of sense of is that, you know, we got used to these free cash flow numbers in past years - you know, over 100 million and that clearly isn't going to be the case any longer.

That's right.

Is there - is there any kind of a - would you perceive any kind of an abnormal change next year versus this year in terms of the overall level of free cash flow?

No, I think what you've likely to see is, you know, the trend at TEL is going down and that's going to be reflected in that free cash flow number. The only thing that I could think of is, you know, obviously, we're trying to manage and balance up the downsizing of our TEL facility at Ellesmere Port and that may mean we have to invest a little bit more in inventories as we get to the end of next year to satisfy demand. But it's far too early to tell at this stage.

That brings up another question. You guys have talked about, in past two or three years, about the difficulty of the rationalization process in terms of dealing with the politics and all that of downsizing both people and plant. Where are you on that now? Are things in pretty good shape in terms of what you've already done and what you intend to do or are there still some sticky wickets from a country standpoint or what have you, in that regard?

Good question. We've pretty much done what we said we would do. Out TEL's got a lot of good history in terms of managing - and it's really, it's really social legislation and - that we have to worry about. But we have a history - we've - since 1996, we have closed a TEL plant in France, one in Italy, one in Germany. We've downsized in the UK. We've done quite a lot of this stuff. So we're quite used to it. But we do know how long it takes. What we hadn't done before is to try to take three or four countries in the EC all at the same time and balance the books. And that's what's taken a little bit longer.

But I think Paul mentioned in his comments, we've pretty much completed the program. The people that are going have been identified, they've been told, the right papers are in check. They may not be getting out of the door for another 10, 12 months or so, but everything, I think, is pretty much done. It's just a case of working through the process now. So we don't expect any more hiccups going forward on that program.

OK. If my math is correct, it looks like your net debt is down to 88 million, which I think is the first time in a long time you're actually below 100. Given the refinancing you have to do and what have you and making the presumption that you don't get lucky and find any cheap acquisitions, I'm assuming that that's a number that actually is going to fall further next year.

I mean, obviously, you know, that goes back to your question, , earlier about sort of what cash we can expect to generate over that time period. It's, you know, we had a good quarter because of the timing at collections and everything else and actually, we weren't really in bank overdraft. It was just one of our small that had a small overdraft. But, you know, we are looking to refinance all of the debt and then create a facility that helps us with working capital and maybe some additional headroom as well, but at relatively modest levels. Because I'm actually more concerned about making sure that I've got some liquidity in the business that allows us to do a range of different things as we move into 2004 on the - in the balanced way that we've identified before in terms of buybacks, dividends, acquisitions and generating free cash in the business.

OK. And I think, one final question. You alluded to the continual lumpiness of the TEL business. Again, if my math was correct, it looked like specialty chemicals was about 38% of third quarter revenues, which is clearly lower than normal. But I guess that's primarily because TEL was larger than normal. Can you give us some feel for what you guys think will be the mix of specialty chemical in terms of the overall revenues, both next quarter and perhaps a first cut of 2004?

I think - it's very hard to put an absolute finger on a number on that one, , but I would say your point about quarter three is absolutely right because, obviously, the TEL sales were significantly higher than the same quarter last year and specialty chemicals were higher, which gives them a greater mix. The specialty chemicals business tends to not have the - anywhere close to the same lumpiness of the TEL operation and we are expecting to see that business grow next year. And we expect to see the TEL decline by the 15%. So, on that basis, you will see specialty chemicals becoming an increasingly greater portion of the overall revenues for the business.

And finally, how many shares have you bought with that $1 million.

I mean, if you look at the average share price that we've been looking at over that time period, I mean, we started off at something like around . I think we exited - I think the last one was around - is wherever that calculation would be in terms of the average. It's not - it's not a lot of shares. It's probably around 55 to - about 55,000, something like that.

OK. Thank you very much.

Thank you. And at this time, we have no more questions in the queue, so we would like to give you another opportunity to signal. You can hit star, one your ask your questions. Do keep in mind your - if you are using a speakerphone, please ensure your mute function has been turned off. And it does not look like we have any further questions. Mr. Kerrison, I will turn it back to you for closing remarks.

OK. Thank, . Thank you, everybody. Your questions and comments are greatly appreciated by us and they assist us in understanding you and our shareholders' needs. I've really got two wrap-up messages for today. The first, as we said in our quarter two teleconference, that we believe our shareholders receive tangible evidence of our ability to grow specialty chemicals by year-end. I think the evidence is now there, which should be reconfirmed at year-end. The full benefits, as said previously, will flow through in 2004.

The second point is we are managing the TEL market decline as well as can be expected by coping successfully with exceptional and unexpected challenges in this area. To achieve a gross margin of 53% for the quarter, a company record high, we have controlled costs and optimize prices. Before, it was mentioned certain customers poured orders into Q3, so we don't expect to beat 2002 year on year, but we still expect to deliver on or above expectations and regain excellent cash generation for the business. Thank you all for your participation.

And that does conclude today's program. We do thank you for your participation and you may disconnect at this time. Have a wonderful day.