Innospec Inc (IOSP) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to today's Innospec Incorporated second quarter results conference call. For your information, this conference is being recorded.

At this time, I would like to turn the call over to your host today, Andrew Hartley. Please go ahead, sir.

Thank you. Before we start, I would like to remind everybody that certain comments made during this call might be characterized as forward-looking statements under the Private Securities Litigation Reform Act of 1995. 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 the 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 own website at innospecinc.com 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 and in the presentation that follows, a copy of which is available on the innospecinc.com website.

With us today from Innospec are Paul Jennings, President and Chief Executive Officer, Ian Cleminson, Executive Vice President and Chief Financial Officer, and Patrick Williams, Executive Vice President and President, Fuel Specialties. And with that, I'll turn it over to Paul.

Thank you, Andrew, and thanks to everyone on the call for taking this time to join us.

On slide 4, I have a few summary comments about our results before Ian takes us through the numbers in greater detail.

First, we are very pleased with the overall results. Our two ongoing business segments, Fuel Specialties and Performance Chemicals, boasted a 24% revenue gain on a combined basis, and their combined operating income was up 44% from a year ago.

On a GAAP basis, diluted EPS was $0.27, up sharply from $0.04 a year ago. Both these numbers are adjusted for our recent two-for-one stock split. The results include a smaller charge for octane additives goodwill impairment this year, but they also include noncash charges related to our United Kingdom pension plan under FAS 158 for the first time.

EBITDA for the quarter was $23.1 million, up 17% from a year ago. One of the highlights of the second quarter was our successful resolution of our disputes with Ethyl Corporation regarding the two companies' global marketing and supply agreements for Tetra ethyl lead.

While the settlement and sale and optimum cash payments from Innospec to Ethyl, it will significantly enhance our ongoing cash flows from the TEL business.

Overall, the second quarter financial results were somewhat ahead of our expectations, but we remain comfortable with the 2007 guidance ranges we previously provided for both Fuel Specialties and Performance Chemicals. We have increased our guidance for octane analysis mainly to reflect the benefits of the Ethyl settlement.

And, with that, I am going to pause and turn it over to Ian Cleminson, our Chief Financial Officer.

Thank you, Paul. Turn to slide 6 in the presentation. On a consolidated basis, revenues for the quarter increased $0.18 despite lower sales in octane additives. As Paul noted, we saw continued strength in Fuel Specialties and Performance Chemicals.

The company's overall profit percentage was lower reflecting margin pressure primarily due to sales mix in Fuel Specialties partially offset by increased margins in both performance chemicals and in octane additives.

Reported earning per share on a diluted basis was up sharply. Results included octane additives goodwill impairment and a restructuring charge in both areas as well as a noncash charge from FAS 158, which is an ongoing item we did not have a year ago.

As stated, all these items are detailed in our press release, diluted earnings per share was $0.47, up 12% from $0.42 a year ago.

Turning to the individual business segments starting at slide 7, fuel specialties, our largest business unit, we had another excellent quarter with revenue growth at 28% and operating income of 32%.

In the Americas, sales growth began strong with a 26% year-over-year increase. [Liquidity] products were a key driver supported by good (inaudible) volumes. Results (inaudible) and benefited from the more favorable (inaudible) of our products allowed in the Ethyl settlement.

In our Europe, Middle East, and Africa region, sales were up 31% thanks to a strong sales performance on [liquidity] products.

In the Asia Pacific region, sales were up 18%, in part reflecting strong volume from Shell and Petrobas.

The second quarter profit percentage was down 3 percentage points largely due to changes in the sales mix such as growth in (inaudible) volume in the U.S. and diesel detergents in Asia, both of which carry lower margins.

In addition, raw material costs, most of which are oil-based, put some downward pressure on margins during the quarter.

For the first half of 2007, fuel specialties were (inaudible) of 2007 full-year revenue target of 8% to 12% growth. We still believe that's a reasonable range. Our comparisons are going to become much more challenging in the second half as we cycle against (inaudible) sales including pipelines for links related to the introduction of (inaudible) last year.

In addition, keep that in mind, our fuel specialty sales in last year's second half included a one-off $10 million sales (inaudible) that is not going to recur.

Moving on to slide 8, in performance chemicals we reported our fourth quarter in a row for strong comparisons. Revenues increased 15% year-over-year, gross profits were 38% in dollar terms, and the gross profit percentage was up 3.9 percentage points.

Operating income was $1 million compared with a small loss a year ago. Exchange rate fluctuations accounted for about a third of the segment sales growth, but most of our businesses in this segment achieved higher volumes and selling prices.

On a comparative basis, Aroma Fine chemicals had a very strong quarter, but they represent a very weak quarter a year ago. With the resolution of our manufacturing machines, they achieved a revenue gain of more than 20%, a very substantial margin improvement.

The Leuna business continues to successfully transition the higher-margin wax segment and also posted revenue growth of more than 20%. Our personal care business in the U.S. saw good growth as well albeit some pressure on their margins.

As in fuel specialties, our quarterly results in performance chemicals were well ahead of our annual growth targets, but we expect significantly significant comparisons in the second half (inaudible) with our previous guidance at this point.

Turning to slide 9, the octane additives segment had another strong quarter. Its revenues were down a relatively moderate 6% reflecting a 12% bottom decline partially offset by higher selling prices. The business has lost no major customers so far this year.

The gross profit percentage for the quarter of 60.7% was up 2.4 percentage points from a year ago, mainly reflected in the fact that we no longer pay Ethyl marketing fees. That factor, with the favorable sales mix, offset the high cost of production due to lower unit volumes.

Reflecting our (inaudible) shipments on the Ethyl settlement, we are raising our 2007 guidance for both revenues and gross margins in the octane additives segment. We now expect revenues to be down 10% to 15% for the year compared with our previous expectation of a 15% to 25% decline, and gross margins are now forecast in a range between 50% and 55% compared to our previous range of 39% to 45%.

While the outlook for 2007 is better than we previously expected, there should be no misunderstanding about the longer-term prospects of this business. We still expect significant revenue in gross profit declines in 2008 and beyond.

Moving on to slide 10, corporate costs for the quarter (inaudible) 7 million up from 4.7 million a year ago. Most of our corporate costs are denominated in sterling, which has appreciated significantly compared to the dollar, driving most of the increase.

That's another impairment charge of 3.3 million for the quarter less the cost of 7.7 million charge a year ago. We remind you that these are noncash charges.

Restriction charges for the quarter were 1.3 million, mostly related to cyclones in the UK down from 3.1 million a year ago.

We've also recorded another noncash charge of 1.3 million related to our United Kingdom Pension Plan under FAS 87 and FAS 158, which we adopted at year-end. As we have mentioned before, this will be a regular feature in our reported earnings, going forward, that was not in our numbers last year.

The adjusted effective tax rate for the year, downward from 35% to 33% resulting in a 30.3% effective tax rate in the second quarter. (inaudible) successful conclusion of some historic tax issues, (inaudible) increased profits from the Ethyl settlement of a tax primarily in low-rate countries which drive our overall tax rate down.

Turning to slide 11, our liquidity remains very solid with cash at 34.8 million, signed debt of 120 million, and net debt of 85.3 million.

During the quarter, we drew down 45 million of fund debt from Ethyl settlement including 28 million compensation (inaudible) and approximately 17 million (inaudible) of the working capital and payables held (inaudible).

Five million of the debt drawn down has already been repaid since the end of the second quarter, and most of the remaining advance is expected to be repaid by year-end.

During the second quarter, we have generated operating cash flows of 10 million before the (inaudible) of debt for working capital arrangements.

In the quarter there was a 23 million outtake working capital of about 17 million is actually related to the Ethyl settlement of the balance sheet position of (inaudible). Outside of this our inventory remains essentially flat, and accounts receivable well under control with eight-day turns with day sales outstanding of 48 days.

I'll now turn it back over to Paul for some concluding comments.

Thank you, Ian. (inaudible) illustrates our concept of ongoing operating profitability. This is a metric we developed to reflect the octane additives contribution steadily declines off our continuing growth businesses in fuel specialties and performance chemicals reflect the future of the company and our corporate costs have to be more in line with a company of our size.

Two years ago, we were operating at a loss on this basis. As you can see on the slide, our ongoing operating profitability for the first half of 2007 was up 48% from a year ago, and if you look just at the second quarter, we were up 62% from a year ago.

On slide 14, we again provide our revenue and gross margin guidance ranges for 2007. As Ian has already discussed, we are not changing our expectations by the fuel specialties or performance chemicals, but we have raised our expectations for octane additives mainly to reflect the favorable settlements of our disputes with Ethyl.

Moving on to slide 15, just a few more points here before we take our questions. We continue to look at potential acquisitions. As many of you know, we have unfortunate experiences with some of our acquisitions a number of years ago, so we have been on the sidelines for a while.

In the two years since I was named CEO, we've focused primarily on improving the performance of our core businesses. Now that those businesses are much stronger and given our strong liquidity and borrowing capacity, we have begun looking at some potential acquisitions, but we are under no pressure to make acquisitions just for the sake of doing deals. Any acquisitions we do will have to complement our existing businesses and be accretive for our shareholders.

Overall, we continue to make excellent progress in building shareholder value. Our second quarter results again demonstrate our success in improving the fundamental performance of our ongoing businesses in fuel specialties and performance chemicals over the last two years.

We also have significantly reduced corporate costs over that timeframe. Meanwhile, we continue to manage the decline in octane additives responsibility, and the settlement with Ethyl will help us move forward unencumbered in that business over its remaining life.

As we've discussed previously, we have taken a much more proactive approach in communicating with the investment community and the media. We have also improved our capital management. During the quarter, the company repurchased another 240,000 shares on a post-split basis of Innospec common stock. That brought total repurchases for the year-to-date to 350,000 shares at a total cost of about $10 million. We still have authorization from the board of directors to repurchase an additional 10 military of Innospec stock.

We think the results ultimately are reflected in our stock price and increase in shareholder value. After nearly tripling its 2006, Innospec shares at the end of June have moved us another 27% so far this year, and I'm sure you're all aware that we recently split our stock 2-for-1, another reflection of the strong performance of the stock over the past two years and, more importantly, of our confidence in the future of Innospec.

And now we'd like to turn over the call to the operator and to take any questions that you may have.

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions) Jeff Zekauskas, JP Morgan.

Good morning, this is [Olga Gutinyova] for Jeff. My first question is about your octane additive segment. So your Ethyl settlement, what was the dollar effect in the quarter and how it affected the gross margin?

Olga, this is Ian and, obviously, we have to be pretty careful what we say about the Ethyl settlement, and because it's part of a legal agreement with Ethyl. And I think when you actually look at the book side, some quarter-over-quarter things, do the math yourself in the increasing gross profit advantage, Quarter 1 margins were around 49%, the Quarter 3 margins were around 60%, and what we've done there is we've taken out the 33% profit that we previously paid to Ethyl, and so that will no longer be a feature of ours going forward. So we're going to benefit from not having to pay that over.

Oh, in other words, if not for the settlement, your gross margin would be, like 44% to 49% in that level?

That's right, Olga.

And, going forward, so you have changed your gross margin outlook for the year to 50%, 55%, which implies that second-half margins will be somewhat lower than in the second quarter? So was it, like, something unusual in the second quarter -- that's why your margins were so high?

No, Olga, that's the full-year range is 50 to 55 --

(crosstalk)

To get to this range, your gross margin should be lower, like, I don't know, 53%, 54% for the rest of the year?

Olga, this is Paul. As you know, with our (inaudible) business, we don't look at that business on a quarter-to-quarter basis because of the timing of shipments and the lumpiness of the operation. So we always feel that it's better to look at that business on an annual basis, and I think the Quarter 2 margins include, as Ian mentioned, some of the pickup from the settlement, but I think the range of 50 to 55 for the year, as you know, we try to be relatively conservative in what we're doing to make sure that we can deliver those numbers. But we feel like it's a good range, and I think, looking on an annual basis, is probably more appropriate given the size of that business now and the timing of shipments, which can slip from one quarter to another.

And as for the next year, you mentioned that (inaudible) next year, but should we expect the same level of gross margin for '08 because of the Ethyl settlement?

I think what you will see as you move forward, and we haven't yet given any guidance for 2008, but the two points that Ian's mentioned -- first of all, yes, there will be a benefit from the fact that we retain 100% of the profit, and that will have an impact. There also is being mentioned, as volumes decline in that business, then we have a certain cost base that we have to [cover on our side], and that would have a negative impact with regard to the margin.

I think the other aspects of it are what level of pricing we actually have for next year and also the mix of customers that we have as well. And what we will do is, toward the end of this year, we will indicate some more detailed guidance for 2008 based on the position of that guidance.

Okay, and the last question is (inaudible) fuel specialties segment. Could you give us, like, more details on the performance (inaudible) clients in the quarter?

This is Ian, I'll just (inaudible). We remain very comfortable with our margins in fuel specialties in the range of 32% to 36% for the full year, and we said earlier that sales mix had played a part this quarter below margin profits a little bit more for the fall and some downward pressure from raw material pricing, which increased about an average of 7% year-over-year.

And (inaudible) it's very much year-to-year and not sequentially quarter-to-quarter, and we remain very comfortable with what we're seeing this quarter and this year so far.

I guess what I was trying to ask is about the performance of the product lines within the segment -- like separate products.

Olga, this is Paul. As you know, we don't publish any more detail behind that fuel specialties number than we build our market position for it, because a number of our competitors, their numbers actually vary within many of the areas that they are reporting. So we have to be careful in that situation.

I think if I was summarizing the fuel specialties business, I would say we know it's a competitive market. We've known that for some time. We try and mitigate that through innovation and to having a sort of customer service model, which is really important to us. I think we've seen the benefits of that with a significant proportion of our sales coming from products we've introduced in the last five years.

As you know, we were the first company to have a range of all sorts of diesel additives. All that specification in the U.S., and we've benefited from that in terms of pipeline (inaudible), et cetera, and we continue to benefit from it, as you would expect that area is coming under some pressure.

I think the key for us within this area is to keep the momentum going on innovation, keep doing that side of it and, quite frankly, we're very pleased with the performance in that division, and we expect that to continue.

Jonathan Lichter, Sidoti.

First a question on the fuel specialties division -- you mentioned that diesel detergents were growing in Asia. Do you expect that to continue? Is that kind of a resurgent there?

Good morning, Jonathan, it's Patrick Williams. We do expect that if you look at Asia Pacific, in general, they're starting to come under new regulatory pressures, and as we do that, because you have a heavier crude being processed in refineries, you are going to need detergent.

Also, with the new technologies coming out with cars, HSDI, et cetera, there will be new technologies for detergents, we're on the forefront of it, and we feel like, really, it's still and up-and-coming market, and we feel it's very well positioned in Asia Pacific.

Okay, and what's driving the strong results in Europe?

Product mix is driving the strong results with very good product mix, as well as we've entered countries where we really have not had a good foothold in the past. On the (inaudible) and performance products have really taken off in numerous countries, like I said earlier, alluded to, where we didn't have much really pride nomenclature and/or did not have employees directly calling on those areas of the world.

Okay, and a question about your guidance. I guess, even at the high end for fuel specialties, it kind of implies, I think, only a 2% gain for the second half of '07?

Jonathan, this is Ian, and we've got exciting events in the second half of the year is some pretty strong 2006 sales, and we should also bear in mind that we had a one-off sales contract in the second half of 2006 of $10 million, and that's what we're going to be up against, and we feel very comfortable with the range of 10 to 12%, and we certainly expect to be at the top end of that.

Okay, so, I guess if you exclude the one-time contract, it doesn't look like, well, say, it's, I guess, around 7% or 8%. Is that the kind of growth we can expect in '08 as well?

I think (inaudible) fuel specialties, and we're very pleased with the levels of growth that we achieve. We're certainly ahead of our competitors. The market is growing at a much lower rate than we are actually achieving. Longer-term, we expect this business to run about 10% growth rate for our business. That will be ahead of the competition and the actual market growth.

Okay, and a quick question on performance chemicals -- you mentioned margin pressure in the U.S. What accounts for that?

This is Paul. Our U.S. business is principally around the personal care side of the business, and what we've been able to do in that business is post some top-line growth and velocity on the (inaudible) levels, and we obviously want to get positions in certain key accounts. That's probably just weakened the margin a little bit for that quarter, but we don't expect that to continue on a long-term basis, which is an opportunity to gain a foothold so we can actually grow that business in the future.

Okay and, lastly, on octane additives -- are you hearing about any kind of rumblings in any countries that they are looking to end TEL use?

Again, as you know, we don't talk about specific countries but, to be honest, at this particular moment in time, and it's quite a fluid situation, as you know, but we are not hearing any massive rumblings of any exits, but we are seeing declining purchases as certain countries [dump through], upgrade refineries, and move forward into another fuel but, specifically, we don't see any countries exiting at this stage.

(Operator Instructions) David Wilson, Smith Barney.

Good morning, guys, good quarter.

Hello, David, thank you.

The TEL inventories, it looks like they've grown a little bit. Do you think those are going to continue to grow over the next year?

David, this is Ian. No, we expect our inventories in TEL to actually stabilize, and, if anything, start to come down. What you've seen this quarter is a small uptick from the Ethyl settlement where we had some inventory (inaudible) from our inventory. Now that's unwound, we see the smaller (inaudible) quarter but longer-term stabilization decline in 2008.

Does that inventory just carry that cost?

Yes.

And could you tell a little bit more about the settlement? Do we now supply worldwide NASCAR AV gas including the U.S.?

David, this is Paul. The settlement, as you know, the marketing agreements were principally for sales into the (inaudible) area outside of North America. So we've settled all those to both companies' benefit, so we're confident about, right now, in, say, none of these positions.

With regards to the TEL that's used in aviation fuel, that's reported as part of our fuel specialties segment and as part of the settlement with Ethyl, we've agreed pricing to them for their supplies into the North American market and also some volumes as well. So, overall, we feel as though it's a nice benefit to Innospec in terms of what we've been able to do with that settlement.

I'm sorry, the connection is not quite clear -- you said "We've set prices with them on what we sell them into the and what they resell into the AV gas market," is that right?

Yes, we've renegotiated a pricing schedule to support the sales for them into the North American market for that term.

And earlier, also, I think you said, but I just want to check, that the TEL market was a little lumpy with us this quarter. Is that correct?

On that one, David, and you know this one, very well, having been supportive of us for such a long time, we don't look at this business from a quarterly basis. I think that the key with octane additives, if you look at the annual guidance numbers that we publish, the size of the shipments that we have and now with the declining customer base, then a shipment going out in June versus July can have a material impact in any particular quarter.

So I think the good thing, from my perspective, is that when you look at octane additives on a full-year basis, we've been able to reduce the decline that we thought we were going to see for that operation and also increase the margins in that area as well.

And, yes, the majority that we like to the Ethyl settlement, in addition we've seen a different position in that market as well, which is benefiting our results.

And you still have some pricing flexibility in TEL?

I think we do. I think that we have to -- we always have to walk a fine line between making sure we get a competitive price for what we sell, and allowing our customers to have an orderly [breakdown] of the TEL in that particular market. I think there is some potential. Maybe it's not as great as we've seen in the past, but it's certainly something that we will continue to look for as we take this business through to the next few years.

One last on this -- the AV gas volumes look like they're stable to increasing just a little bit?

We don't quote specific volumes. I think if you looked at the AV TEL market, overall, it's in line with where we see it. What we've meant to say in that market it's going to be broadly the same or maybe a 1% or 2% decline in terms of volume over the longer term. But with some opportunity to look at pricing, but I think from where we are for the first six months of this year, the results in that particular market are quite pleasing.

Thank you, guys, good quarter, again.

David, thanks for your support.

Thank you. It appears there are no further questions at this time. Mr. Jennings, I'd like to turn the conference back over to you for any additional or closing remarks.

Thank you very much, and thank you to everybody for your questions. I would like to leave you with some final thoughts, which are shown on slide 17. Our second quarter results demonstrated the continued strong momentum in our ongoing growth businesses in fuel specialties and performance chemicals. Although the pace is likely to slow a little in the second half, we continue to believe that both of these segments will again post strong results for the full year, and these two segments accounted for 85% of our revenues in the second quarter. So we're very optimistic as we look ahead.

If you have any additional questions, please don't hesitate to give either Ian or myself a call. In any case, we look forward to sharing our third quarter results with you in early November. Thanks again for being with us today. Goodbye.

That will conclude today's conference, ladies and gentlemen, thank you for your participation and have a good day. You may now disconnect.