Innospec Inc (IOSP) 2007 Q4 法說會逐字稿

Good day and welcome to the Innospec Q4 and full-year 2007 results conference call. For your information, today's conference is being recorded. At this time, I would like to turn the call over to your host today, Mr. Andrew Hartley, Vice President and General Counsel. Please go ahead, sir.

Thank you and good morning, everyone. Thanks for joining our fourth-quarter 2007 financial results conference call. Today's call is being recorded. As you know, last night, we reported our fourth-quarter and full-year 2007 financial results. The press release is posted on the Company's website, www.InnospecInc.com. An audio webcast of the call and a slide presentation on the results are also now available and will be archived on the website.

Before we start, I would like to remind everybody that certain comments made during this call can be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Generally speaking, any comments regarding management beliefs, expectations, targets or other predictions of the future are forward-looking statements. These statements involve a number of risks and/or 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 site or our site act, Innospec Inc.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 Innospec website.

With is today from Innospec are Paul Jennings, 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, Paul.

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

Turning to slide 4 in the presentation, I have a few summary comments about our results before Ian takes us through the numbers in greater detail. Overall, we're very pleased with the results for the quarter. Total revenues were up 19% with GAAP EPS on a diluted basis of $0.45 a share compared with a $0.03 loss a year ago. The results included Octane Additives goodwill impairments and a small restructuring charge totaling $0.08 per share in the fourth quarter of 2007 compared with similar charges totaling $0.34 per share a year ago.

Our EBITDA for the quarter was at 40% from a year ago. Fuel Specialties led the way in the quarter, with impressive revenue growth of 16%, well ahead of expectations. Octane Additives rebounded as we expected from the third quarter, although there has been no change in our longer-term outlook for a decline in that business over the next few years. Active Chemicals results were slightly below our expectations, but we continue to believe that our restructuring of that segment early in the fourth quarter has positioned it for a better performance in 2008.

For the full year, we delivered revenue growth of 13%, generally maintained our margins at strong levels in the face of numerous cost pressures, increased our investments in capital expenditures and R&D, and delivered earnings per share on a GAAP basis of $1.19 per share more than double the $0.45 per share we reported for 2006.

We generated free cash flow for the full year of nearly $36 million and used over $18 million to buy back our stock. In short, we continue to execute successfully against our stated objectives, which are to run our core businesses better, to control our costs, to manage our capital effectively and to improve the visibility and understanding of Innospec, and we are looking forward to further growth in 2008.

And with that, I'd like to turn the call over to Ian Cleminson, our Chief Financial Officer.

Thank you, Paul. Turning to slide 6, on a consolidated basis, revenues for the quarter increased 19%, mainly due to continued strength in Fuel Specialties and an expected rebound in shipments at Octane Additives. The overall gross margin was 31.4%, down 70 basis points from a year ago. Margins in Fuel Specialties, which is by now our largest business, improved, but this was more than offset by lower margins in Octane Additives and Active Chemicals.

Operating income of $15.4 million was up 54% from a year ago. EBITDA was $27.3 million, up 40% from last year's fourth quarter. Our GAAP earnings per share of $0.45 on a diluted basis was up significantly from a loss of $0.03 a share a year ago.

Turning to the individual business segment, starting with slide 7, in Fuel Specialties, we had an exceptional quarter with reported revenue growth of 16%, which was achieved despite the absence of $6 million in revenues from a one-off contract included in the 2006 period. Excluding those revenues a year ago, the segment's revenue growth for the fourth quarter of 2007 was 24%. By region, reported revenues were up 16% in the Americas; 21% in the EMEA region -- that's even with the absence of the one-off contract; and 29% in the Asia-Pacific region. Results in the Americas were fueled by very strong product volumes led by [cetane enhancers] and lubricity improvers, as well as solid growth in seasonal winter products. In the EMEA region, sales of cold flow improvers and heating oil additives were well ahead of expectations.

In Asia-Pacific, the strong sales were achieved somewhat at the expense of margins as much of the growth reflected increased sales of lower margin diesel detergents. Overall, however, the segment's gross margin was improved at 31.5% compared with 31.1% a year ago. We consider this a very good performance in view of the increased competition we're facing across our ultra-low sulfur diesel product line and in view of the significant increases we absorbed in raw material costs, most of which are oil-based.

Operating income for the fourth quarter of $18.6 million was more than double a year ago, but we should remind everyone that Fuel Specialties incurred approximately $6.2 million in expenses related to onetime professional fees and a potential customer claim in the 2006 period. Adjusting for those, Fuel Specialties' operating income was up 26% from last year's fourth quarter.

Moving on to slide 8, as Paul noted, our results in Active Chemicals were a little disappointing for the quarter. Revenue growth was 8% overall. We gained an approximately 7% in both the Americas and the EMEA region on a 31% increase in the much smaller Asia-Pacific business. In the EMEA region, the bulk of the growth was in the polymer sales, which carry lower margins than the rest of the business. Growth in the Americas was fueled by stronger fragrance sales to several key customers. Margins in both regions were also affected by our deliberate assets to slow production and reduce inventory at certain locations.

The segment's gross margin of 16.8% for the quarter was down 3.3 percentage points from a year ago and operating income of $1 million was down $700,000 from last year's fourth quarter. There were some bright spots in Active Chemicals during the quarter, including new product introductions and the restructuring at the beginning of the quarter, which Paul will address later.

Moving on to slide 9, results in Octane Additives were strong with a 52% increase in revenue from a year ago and nearly a doubling from Q3. As we had previously mentioned, the results in Q3 have been impacted by a delay in shipments to certain customers.

Gross margin in the fourth quarter was 46.9%, down 9.3 percentage points. Price increases and the positive impact of [the other] settlements were more than offset by the increased cost of production related to the lower unit volumes, which you saw at our Ellesmere Port facility.

The segment's operating income for the fourth quarter reduced by $4.4 million the legal expenses and accruals related to the SEC and DoJ investigation of United Nations Oil for Food program, which Paul will discuss in greater detail. Excluding these expenses, Octane Additives' operating income for the quarter was up 29% from a year ago. While this business is in good shape and we don't see any signs at key customers about to leave the market, our strong year end finish in Octane Additives does not fundamentally affect our outlook for [progressive] decline in this business.

Moving on to slide 10, corporate costs for the quarter were $6.2 million, held level from a year ago, a strong performance considering that most of our corporate costs are denominated in British pounds. We recorded another non-cash charge of $1.2 million related to our United Kingdom pension plan under FAS 87 and FAS 158, which we adopted at the end of last year. There was another small restructuring charge about $0.1 million in the quarter compared to $1.1 million restructuring charge a year ago.

The Octane Additives' impairment charge was $2 million for the quarter, down sharply from $7.3 million in last year's fourth quarter. At the year end, there was only $12.7 million in Octane Additives' goodwill remaining on our balance sheet.

The tax rate for the quarter was 23.8%, below our expectations and down from 39.4% a year ago. For the full year, the tax rate was up 0.6 percentage points, reflecting the increase in taxable profits in the Fuel Specialties U.S. business.

Turning to slide 11, our liquidity position at the year-end remained solid with cash of $24.3 million, bank debt of $81 million and net debt of $56.7 million. We repaid $22 million of bank debt during the quarter, leaving us with only $6 million remaining from the $45 million we borrowed in the second quarter to fund the acquisition of the Ethyl share of the Octane Additives business.

Operating cash flow was $25.6 million for the quarter and after $3.6 million in capital spending, free cash in flow was $22 million. Working capital remains in good shape at $115.6 million, a $6.5 million reduction from the third-quarter level.

And now I will turn things back over to Paul for some concluding comments.

Thank you. Moving on to slide 13, which illustrates our concept of ongoing operating profitability. This is a critical report card, if you will, on our transformation of Innospec over the last 2.5 years. The point here is that we really need to evaluate the Company's results and operating trends, excluding Octane Additives, which we all know is in long-term decline.

Two years ago, operating income from our continuing growth businesses in Fuel Specialties and Active Chemicals did not cover our corporate costs. As you can see, our ongoing operating profitability continues to improve. For the fourth quarter, it was more than triple the level of a year ago and for the full year, it was up 62%.

Turning to slide 14, which covers our new revenue and gross margin guidance ranges for 2008, in Fuel Specialties, we are looking for revenue growth of 7 to 11% with a gross margin percentage of 30 to 34%. In Active Chemicals, we expect growth of 8 to 12% in revenues and a gross margin of between 18 and 22%. In Octane Additives, we expect to see a revenue decline of 15 to 20% with a gross margin of 43 to 47%. In addition, in 2008, we prudently expect the tax rate to be approximately 35%.

Moving on to slide 15, I wanted to touch on a few more points before we take your questions.

Two years ago, we changed the name of the Company to Innospec and the innovation concept that inspired our new name is very much a reality today across our ongoing Fuel Specialties and Active Chemicals businesses. I am pleased to report to you that our research and development expenditures for 2007 were $13.6 million, a 23% increase from 2006. Also, I wanted to update you on a metric we provided a year ago.

In our Fuel Specialties segment, fully 43% of our sales in 2007 came from products developed over the previous five years. A year ago, the corresponding figure for 2006 was 38%. In Active Chemicals, introduced five new Fragrance Ingredients during 2007 and filed seven new patents with the patent office. We also filed eight patents in Fuel Specialties in 2007.

On the subject of Active Chemicals, we have acknowledged that the fourth-quarter results were somewhat disappointing. However, we remain confident that the realignment of this business at the beginning of the quarter was the right strategy, and we do see early signs that the new strategy is bearing fruit.

As you know, we have reorganized the division into three geographical regions as we have done in Fuel Specialties -- the Americas, EMEA and Asia-Pacific, And also across five target markets, Fragrance Ingredients, Household, Industrial & Institutional, Personal Care, Plastics & Polymers and Pulp & Paper. Our Active Chemicals salespeople are now selling all of the division's products and services to every customer that they can call on.

As Ian noted, we booked $4.4 million in expenses for the quarter relating to the SEC and DoJ investigation of the U.N.'s Oil for Food program. This breaks down into about $700,000 in actual legal expenses during the quarter versus a $3.7 million accrual for expected legal expenses during 2008. As we disclose during the quarter, we have received subpoenas from the SEC requesting additional information and we are cooperating fully with that investigation.

Finally, we continue to look at impossible acquisitions and, in fact, turned down three potential opportunities during 2007. While we are eager to grow the Company, we're not under any pressure to do a deal. Any acquisition we consider seriously will have to complement our existing business and be accretive for our shareholders. And now we would like to turn the call back to the operator and take any questions that you may have.

(OPERATOR INSTRUCTIONS). Jeffrey Zekauskas, JPMorgan.

One of the themes of your conference call has been that your consolidated tax rate for the year was relatively high because you are making so much money in Fuel Specialties, which is in the U.S., largely, or this big component there. But in the fourth quarter, you had the highest results of the year in Fuel Specialties, but a tremendously low tax rate relative to the third quarter. So how is that possible? (multiple speakers) so low?

Jeff, this is Ian. As you are aware, we true up the tax charges at year end. We do keep a very close eye on it, the effective rate, as we move through the year. And what we've been able to do is to do some internal tax planning so the origins of our profits have been slightly realigned in the fourth quarter.

Also, we are at the stage now of filing our 2006 returns as well, so we're able to true up some of the actual positions that we have brought forward as well. So longer term, we expect the effective rate to drift higher up as we have more profits in the U.S. and the guidance we've given is that the effective tax rate will be 35% in 2008.

So if I understood what you just said to me, there were some benefits from previous tax years that you booked in the quarter from 2006?

Yes, as we trued up the year, the final filing position on 2006, we were able to release some of the previously held charges through P&L and also as we target up the 2007 year end as well, managed to lose some profits around the organization, we're able to lower the tax charge slightly as well.

Okay. Now, if I remember correctly, next year, your amortization costs really drop down in tetra ethyl lead. My memory is that they fall about $9 million. Does that affect your book tax rate? And is that a correct memory of mine about your amortization charges?

You're absolutely right, Jeff. It's $10 million on this amortization finishes the end of the 2007 calendar year. We have to take a deferred tax asset and liability view of that and that will [unwound] in the 2007 position. And going forward, our profits really now are going to be very much centered in the U.S. and also in the UK, and we have to fold that into the mix. But we will, as I said earlier, see a drift upwards in the effective tax rate.

Okay. Third, in Fuel Specialties, if you sort of break it into say diesel, auto, and heating oil, how did those different pieces perform in the fourth quarter relative to each other?

Jeff, this is Paul. We don't, as such, report the numbers in that particular area, but I can broadly comment on those three areas if that makes sense. If you looked at the -- the diesel aspect, is by far and away the largest part of our Fuel Specialties business, and we have seen some uptick in that based on the treat rates in ultra-low sulfur diesel and the increased penetration, particularly in the U.S. market. We also saw a little bit of uptick in some of our cold flow sales as well, particularly in Europe, which helps spur business and also in the heating oil segment as well. The automotive side, and by that I'm assuming you mean gasoline --

Yes.

-- didn't have that dramatic impact on that quarter's results. It's more about the diesel, the cold flow and the heating business.

Lastly, in Octane Additives for the year, can you give us a rough idea of how much your volumes changed and your prices changed?

Again it's Paul. What we've seen in -- if you look for the quarterly position, we actually saw quite a significant increase in volume as far as the quarter was concerned. Just -- which was almost 50%. If you look at the full year position, though, as far as the split on pricing etc., and on volume, we have been able to get prices up on the full year a little bit over what we saw in 2006. And volumes are sort of slightly declined in the business and not at the level that we were originally expecting. We still see longer term that that business is going to be in decline. I think we said 15 to 20% for 2008. But 2007 was a better year.

I think the only thing I would caution on that, which you obviously know well, is that it does get quite lumpy from quarter to quarter. We mentioned that quarter three we had a poor Q3, but it was going to rebound back in Q4 and that's what we've actually seen.

I think the only other comment I would make is that we are not forecasting at this moment in time any country exits. We've just seen a gradual decline in that business in 2008.

Just and lastly, so if next year your amortization costs go down about $10 million in Octane Additives, that will be a benefit at least to your book operating income. And you expect Fuel Specialties to grow and I guess you expect to fix whatever is going wrong in Active Chemicals. So all things being equal, operating profits should grow in all three segments. Is that right?

If you look to -- you would expect to see growth in operating profit and Fuel Specialties and the Active Chemicals. In the Octane Additives business, the way we tend to look at operating profit is before amortization. And obviously we would expect to see that picture decline as we're looking into 2008. I think if you brought the amortization in, then you're probably going to see broadly the same level as 2007.

Okay, thank you very much. Thank you for your patience.

Jonathan Lichter, Sidoti & Company.

How much of the Fuel Specialties performance do you think was related to a cold winter in Europe? How much would it have been up if the winter had just been average, let's say?

Jonathan, this is Ian. And that's quite a tough one to call, actually. The fourth-quarter results were above our expectations, and a couple of factors really caused that growth that we could manage, but we couldn't necessarily forecast. Firstly, the cold and unexpected weather caused greater sales in our cold flow and heating products. And secondly, our competitors were caught short of inventory and therefore we bought problems, and that wasn't necessarily something that we could foresee, but something that we could manage. So it's difficult to put numbers around that because we just don't know how the weather is going to pan out, Jonathan.

Right. Understood. Did you see any indication of a slowdown in demand in Active Chemicals towards the end of the quarter? It seems like some other companies indicated that that happened.

No, we actually haven't seen a slowdown in demand because our sales were up sort of 8% year over year and driven by some volume change as well. And I know what you are referring to there, Jonathan, about some of the published end users have said about volumes, et cetera. We are not seeing that within that business, which is why we are confident about sort of giving a range of projection that's showing close to double-digit growth for 2008 over 2007. Because we believe we're well positioned now in those businesses, and the new structure will really allow us to grow sales.

Okay. Do you expect any additional accruals for the SEC investigation during 2008?

I think at this particular moment, I'm comfortable with the level of accrual that we've actually got at the moment. It's an ongoing discussion, an ongoing investigation. We're cooperating fully, and I feel that what we have at the moment is appropriate.

What are your expectations for CapEx for this year?

This is Ian again. We expect in 2008 to be spending round about $10 million in capital projects. But we're always mindful that if opportunities come along which are accretive to the Company, we'll take a very hard look at them.

And lastly, in R&D, what kind of spend do you expect there?

We're actually very pleased with our R&D spend this year. We've managed to increase R&D spend year-over-year and we would imagine that it will continue to tick up perhaps not at the same amount that we've done this year, but it's something the innovation in our name is something we hold very close to our hearts, so we won't starve the Company of innovation and R&D spend.

Thank you.

Greg Hillman, [First Wild] Share Security.

Just a couple of things. When you talked about a potential customer claim in Fuel Specialties, what was that? I don't know if you talked about that. Excluding onetime professional fees and a potential customer claim?

Greg, this is Ian. This relates back to quarter four 2006. And you'll probably recall when we were back on the call back then, we had a customer claim, which was $3.7 million and we also had some legal fees from the Ethyl settlement, which was successfully concluded now in June of 2007. They were really considered one-offs; did not recur in the quarter four 2007 numbers, so we wanted to highlight them so that you could actually make a comparison yourself.

(OPERATOR INSTRUCTIONS). [Paul Svelt], [Capital Flows].

Actually you've answered my question, but maybe I could ask you to discuss a bit the income statement sensitivity to Eurodollar strength and also, feedstock costs. And my thoughts are, you have a lot of expenses in euros and a lot of revenues in dollars and that may change that ratio. And also, with the price of oil feedstocks high we may see some changes (technical difficulty).

Paul, this is Ian. That's a fairly big and broad question; I'll do my best to answer it. Like any other multinational business, we are impacted by exchange rate movements. However, our three trading businesses are naturally hedged and the bottom line is fairly widely impacted by movements in exchange rates.

Where we do feel the pain on exchange rates if you want to call it that is in our corporate cost base. That is predominately based in the UK and is predominately British sterling. So as the U.S. dollar is weakened, we have taken a round about 9% increase in our costs.

No what we've actually managed to do in our corporate cost base is maintain it and actually lower in local terms, in sterling terms, our corporate cost base so the effect has been zero across the whole piece. So we're fairly naturally hedged as a business.

As regards oil prices, that is something which we feel is always a benefit to us. The attitude use for [going of] oil is fairly low and so oil prices going up and down doesn't impact us too greatly.

And what we also see is the higher price of oil goes up, refiners are looking always to get more out of each barrel and they have to crack the process harder and that gives us opportunities for additive usage further down the line.

I think also, Paul, and this is Paul Jennings. What I think we've done a much better job of in the last couple of years is actually being able to see what's happening and to be quite proactive about managing our price increases in certain areas. I think we've done a good job of that in Fuel Specialties. I think we are starting to do a better job of that in Active Chemicals.

So Ian is exactly right. What we tend to see is the oil prices going up could actually help us in the round because people are wanting to get more fuel out of what they are cracking and additives are a great way to do that.

Thank you.

(OPERATOR INSTRUCTIONS). We have no further questions at this time. I would like to turn the call back to Mr. Jennings for any additional or closing remarks.

Thank you for your questions. And I would now like to leave you with some final thoughts, which are shown on slide 17.

Our fourth-quarter results were very strong, exceeding expectations, primarily due to the performance of Fuel Specialties which is really our core business. This business is benefiting from our continued investment in innovation and the effectiveness of a service-oriented approach to its markets. Fuel Specialties is delivering excellent performance with a combination of winning new business and growing significantly faster than the markets in which it competes.

Our Active Chemicals segment, as we have acknowledged, is a couple of years behind Fuel Specialties, but we are very confident that our realignment of this business late last year has positioned Active Chemicals to deliver improved results in 2008.

In both Fuel Specialties and Active Chemicals, our ongoing growth businesses, we have strong leadership positions in attractive markets. We remain well positioned to leverage those strengths in the future both organically and through potential acquisitions.

In conclusion, we continue to deliver on the strategy we have communicated over the last few years. We have driven substantial sales growth in our ongoing businesses. We are managing the decline in Octane Additives responsibly and optimizing its cash generation for our shareholders. We have reduced our corporate cost structure to support our ongoing businesses. We have worked hard to improve the visibility and understanding of Innospec in the financial community, and we have managed our capital better at accelerating our share repurchases for the benefit of our stockholders.

If you have any additional questions, please give Ian or myself a call. In any case, we will look forward to sharing our first-quarter results with you in a few months. Thanks again for being on the call with us today and good bye to everybody.

That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.