Innospec Inc (IOSP) 2008 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Innospec Earnings Second Quarter 2008 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Kate Davison. Please go ahead.

Thank you and good morning, everyone. My name is Kate Davison, Group Legal Advisor and Head of Investor Relations with Innospec. Thanks for joining our second quarter 2008 financial results conference call. Today's call is being recorded.

As you know, last night, we reported our second quarter 2008 financial results. The press release is posted on the Company's Web site, www.innospecinc.com. An audio webcast of the call and the 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 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 site for these and other documents.

In our discussion today, we have also included some non-GAAP financial measures. A reconciliation to the most directly comparable GAAP financial measure is contained in our earnings release and in the presentation that follows, a copy of which is available on the Innospec 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 of Fuel Specialties. And with that, I will turn it over to you, Paul.

Thank you, Kate, and thanks to everyone on the call for taking the time to join us. Turning to slide four in the presentation, I have a few summary comments before Ian takes us through the numbers in greater detail.

Despite the continued declines in our Octane Additives business we have achieved positive revenue growth for the quarter with a 3% overall increase. Fuel Specialties, which is now by far our largest business, delivered another solid performance with 10% revenue growth and an improved gross margin.

However, we are obviously somewhat disappointed with our bottom line results for the quarter. Diluted earnings per share on a GAAP basis was only $0.03 compared with $0.27 for last year's second quarter. The results include a write-off of $0.10 per share for advisory and financing costs we have previously accrued in connection with two large potential acquisitions. Ultimately, we feel good about that decision not to pursue these deals, but that decision required that we write off these accrued expenses.

In addition, Octane Additives goodwill impairment, a small restructuring charge and foreign exchange losses partially offset by a small real estate gain caused the net reduction of another $0.09 in our earnings for the quarter.

Ian will give us the full detail on those items in a few minutes. Fundamentally, as I said, it was another good quarter for Fuel Specialties and Octane Additives results were broadly in line with our expectations.

Active Chemicals suffered through a very challenging quarter mainly due to increased energy and raw material costs as well as the continued shift in its sales mix to lower margin products. However, we believe it has hit bottom in the second quarter and going forward, we expect it to benefit from raise in prices across all its markets and to begin to benefit from its integration with Fuel Specialties as part of a single ongoing global specialty chemicals business, which we announced at the end of the second quarter.

While we have adjusted our 2008 guidance ranges to both Active Chemicals and Octane Additives to reflect our second quarter results, we have not changed our expectations for Fuel Specialties. And I would emphasize that overall, the change in our gross profit expectations for the full year is relatively modest. I'll have more to say on this later, but now I would like to turn the call over to Ian Cleminson, our Chief Financial Officer.

Thank you, Paul. Turning to slide six, on a consolidated basis revenues for the quarter increased 3% mainly due to the strong performance in our Fuel Specialties business and an acceleration in sales growth in Active Chemicals, which were partly offset by a substantial revenue decline in Octane Additives.

The overall gross profit percentage was 28.3%, down 5.5 percentage points from last year's second quarter. This drop reflects significant margin declines in both Active Chemicals and our Octane Additives business. However, our gross profit percentage increased for the quarter in Fuel Specialties.

Total operating income of $6.1 million and EBITDA of $9.9 million were both down significantly from the year ago, partly due to the write-off of acquisition costs [stockholders' grant], which was $3.9 million pre-tax, $2.5 million after-tax or $0.10 per share. I will break other items out in greater detail in a few minutes, but altogether, they reduced our income by another $0.09 per share.

A year ago in the second quarter, our results included similar items that had a negative impact of $0.12 per share. If you back all these items off of both years, our adjusted EPS was $0.22 compared with $0.39 a year ago, the difference primarily being Active Chemicals and Octane Additives lower performance. Fundamentally, as Paul noted, we had another good quarter in Fuel Specialties, but a very difficult quarter in Active Chemicals.

Turning to the individual business segments, starting with slide seven, in Fuel Specialties revenue growth was 10% for the quarter, which is well below its 34% growth in the first quarter, but still quite solid considering the macro environment that is facing in both the U.S. and EMEA. Revenues could have been somewhat stronger, if not for some raw material supply issues in certain areas.

The 10% revenue growth was driven by price and product mix, which accounted for 7 percentage points from the favorable impact of exchange rates, which accounted for another 5 percentage points. This is offset slightly by lower volume, down 3 percentage points.

By region, revenues increased 7% in the Americas, due primarily to a [richer price] and product mix. In EMEA revenues rose 18% due to strong sales of detergents and refinery products assisted by the favorable impact of exchange rates.

In the Asia-Pacific region, revenues increased 10% mainly due to strong detergent sales. The segment's gross margin for the quarter was 34.3%, an improvement of 0.6 percentage points from 33.7% a year ago. The increases achieved despite significant raw material increases.

Operating income for the quarter of $15.2 million was up 6% from last year's second quarter. The segment's operating income growth was dampened by increased SG&A expenses, partly reflecting exchange rate differentials in EMEA and higher R&D expenses to support this expanding business.

We should note that Fuel Specialties sales and margins was softer in June than for the full quarter reflecting raw material supply issues and cost increases, which we are aggressively pressing on. But it is fairly clear that year-over-year revenue and profit comparisons in this business will be more difficult in the second half than they have been for the year-to-date. Nevertheless, as Paul noted, we remain comfortably consistent with our original full year guidance ranges for Fuel Specialties.

Moving on to slide eight, our second quarter results in Active Chemicals were clearly disappointing. While revenue growth actually accelerated to 11% from 4% in the first quarter, much of the growth was in low margin polymers.

By region, revenues rose 1% in the Americas where our fragrance business performed well, but results in Personal Care were below expectations and partly due to delayed product launch by a major customer. In EMEA, sales growth was strong with 17%, but mostly the growth is coming from polymers and a favorable impact of exchange rates. The Asia-Pacific region remains relatively small, but reported growth of 33% due to strong fragrance and polymer sales.

The segment's gross margin of 5.3% was down sharply from 17.1% a year ago. In addition to the less favorable sales mix, margin for the quarter were hurt by sharp increases in energy and raw material costs. Average raw material costs were up 20% or more for many of our products while energy costs were up approximately 40%.

Meanwhile in many cases, we have been locked into contracts that prevents us from immediately passing along these costs. Overall, the segment reported an operating loss of $2.4 million compared with an operating income of $1 million a year ago.

As Paul noted, we believe Active Chemicals performance has bottomed out in the second quarter and its results should increase sequentially in the second half of 2008 on the back of major price increases to all customers.

Turning to slide nine, Octane Additives results for the quarter were down significantly, but were generally in line with our outlook for the long-term decline in this business. Revenues of $13.1 million were down 39% from a year ago, while its volumes were down 38%. Volumes remain in line with our expectations though the revenues were adversely impacted by sales mix.

The gross margin for the quarter of 51.9% was down 8.8 percentage points, in part reflecting a shift in the sales mix and our increased unit costs due to the significantly lower production volumes of our (inaudible) facility. In addition, the gross margin a year ago benefited from the Company's settlements in its disputes with Ethyl Corporation.

Moving on to slide 10, underlying cooperate costs for the quarter were held at $5.7 million consistent with the year ago. We have however written off in the current second quarter $3.9 million of previously deferred costs in respect of two large potential acquisitions that we are now no longer pursuing.

As expected, Octane Additives impairment charge is down sharply of $1 million compared to $3.3 million a year ago. We incurred a restructuring charge of $1.1 million primarily for severance expenses in Active Chemicals, compared to the $1.3 million restructuring charge a year ago.

We also have a smaller gain of approximately $400,000 on the disposal of some real estate. We incurred net foreign exchange losses of $1 million, which relate to losses on foreign currency forward contracts and on translation of monetary assets in our European business, primarily due to the weakness of the dollar against the euro.

In last year's second quarter, we had a $1.8 million net foreign exchange gain before taxes. In addition, we recorded another non-cash charge of $0.6 million related to our United Kingdom pension fund down from $1.2 million in last year's second quarter.

Turing to slide 11, our liquidity remains excellent, the $16.4 million cash and cash equivalents, total debt to $81 million, and net debt of $64.6 million. Net debt is [up] $8 million for year-end and almost $20 million from the end of Q1.

Now the free cash outflow almost equal to the cash inflow in the first quarter, reflecting our reduced net income as well as a very deliberate decision to build our inventory strategically in certain product categories.

We repurchased another 86,000 shares during the quarter and for the year-to-date, now repurchased approximately 484,000 shares for a total of 9.6 million. And now I will turn it back over to Paul for some concluding comments.

Thank you, Ian. Moving on to slide 13, which shows Innospec's ongoing operating profitability, this is one of the key metrics we have used to illustrate our success in transforming Innospec over the last three years.

While this measure was down in the second quarter, reflecting the weakness in Active Chemicals, for the six months of 2008 our ongoing operating profitability is $24.8 million, up 15% from the year ago.

I would remind everyone that just three years ago, our operating income from Fuel Specialties and Active Chemicals, our ongoing growth businesses, did not even cover our corporate costs, and we were actually losing money on this basis.

Slide 14 shows the changes we have made in some of our guidance ranges. We remain comfortable with our original revenue and gross margin ranges for Fuel Specialties. In Active Chemicals, we have actually increased our revenue guidance to 10% to 14% increase, up from 8% to 12% previously. However, we have reduced our expectations for its gross margin to 10% to 14% from 18% to 22% previously.

In Octane Additives, we now expect a 25% to 30% revenue decline compared with our previous expectation of a 15% to 20% decline, mainly reflecting our revised outlook for the timing of shipments over the balance of the year. And we now expect Octane Additives gross margin to be between 40% and 44% compared with 43% to 47% previously.

In addition, we now are estimating the full-year tax rates as approximately 34% compared with 35% previously. I would point out that when you do the math from these adjustments through our guidance ranges using the midpoint in every case, they add up to a projected reduction in our total gross profit for 2008 from that originally expected of less than 9%.

Turning to slide 15, I would like to make a few more points before we take your questions. As we've already highlighted, our results for the quarter included substantial write-off of accrued costs for potential acquisitions that we are now not pursuing.

The two deals in question were both large relative to Innospec's current size and required extensive due diligence as well as cost related to potential financing that we would have needed to complete the transactions.

We feel very good about that decision not to go forward with these deals, which ultimately did not make sense for our shareholders. Having said that, we remain open to considering acquisitions on an opportunistic basis. But, as we've said many times, an acquisition would need to complement our existing businesses and create long-term value for our shareholders.

Regarding Active Chemicals, as we have acknowledged, its performance in the quarter was substantially below our expectations and obviously unacceptable. However, we are confident that the worst is now behind it.

We have some good short-term opportunities to improve our pricing on several key contracts, which should offset some of the margin pressure we have been experiencing. In addition, we believe our restructuring of Active Chemicals will begin to show benefits in the near future.

As we announced last month, we have followed up our restructuring of Active Chemicals in last year's fourth quarter, which was primarily a reorganization to three geographical regions, with a further restructuring in which we are actually integrating Active Chemicals organization with Fuel Specialties to create a single streamlined organization.

The new Global Specialty Chemical segment unified under Patrick William's leadership will have a sharp focus on meeting customer needs with innovative products and have culture built around exceptional customer service. We believe the combined business can be just as successful as the Fuel Specialties business has been over the last few years.

On side notes, in our reporting format, we only announced outline to combine Fuel Specialties and Active Chemicals last month, and determined that this quarter was not a good sign to change our segment reporting format given the very different cost currents in the two businesses.

Going forward, however, as that cost structures are increasingly integrated, it will no longer be possible for us to provide the segment information we have report historically, and the line of business information will be combined into a single segment reported on a regional basis.

While our performance in Active Chemicals this quarter represents a short-term setback, I think we all need to remind ourselves how far Innospec has come over the last three years. In fact, we won two more awards in the United Kingdom during the second quarter from the United Kingdom Chemical Industries Association, one for reputation and the other recognizing Innospec as Company of the Year.

In giving the reputation award to Innospec, the awards panel noted, that while we were substantially restructuring our product portfolio, Innospec developed the proactive strategy for engaging with all its stakeholders, which has transformed the poor reputation into one of the most enviable in the industry.

In noting, Innospec Company of the Year, the awards panel noted that strong leadership, our commitment to employees and the community together with innovative new product development as to [see] Innospec grow into one of the best companies in the United Kingdom as voted for by its employees.

We also noted that Innospec now has one of the best safety records in the United Kingdom, having received The Royal Society for the Prevention of Accidents Gold Medal Award this year, so it's worth bearing in mind how much progress Innospec has made over the last few years.

Finally, I wanted to mention that we do not have any new news for you regarding the investigations related to the UN Oil for Food program by the SEC and Department of Justice. You will also be aware that the United Kingdom's Serious Fraud Office has commenced an investigation into the Company's involvement in the Oil for Food program.

This investigation is largely following the course of the SEC and DoJ investigation. As you have probably noticed, we did not take any additional charges this quarter for the related expenses. We continue to cooperate fully with the investigations.

We don't have a view yet as to how much longer the investigations will take or what the ultimate results will be. When we do, we will communicate that promptly. But in the meantime, there is nothing more to say beyond the disclosures we have already made in our 10-K and our 10-Qs. And now, we would like to turn the call back to the operator and take any questions you may have.

Thank you. (OPERATOR INSTRUCTIONS). We will take our first quarter today from Jonathan Lichter of Sidoti. Please go ahead.

Good morning.

Hi, Jon.

Good morning, Jon.

What percentage of Active Chemicals contracts can you get pricing on?

As we have said in the call, there were a number contracts within certain aspects of the business that we have been tied into. But, ultimately, what we are looking to do within Active Chemicals is look for significant price increases across the whole of that business and that's something that we are working on with immediate effects and we are looking to push through over the coming months.

Are you actually prepared to walk away from some business if you can't get pricing?

I think we have to look have at each individual pieces of business on that, Jonathan, in terms of the actual margin and contribution it makes. But if we felt that it was detrimental to Innospec, then yes, we'd do that.

And, did you have or how early did you have visibility into these rising costs or how early in the quarter?

Jonathan, this is Ian. What was seen in the last quarter in Active Chemicals is price increases with base raw materials of anything from 20% to 35%. And in addition, we have seen energy cost increasing over 40%.

When you actually track that through the quarter, we have seen a real spike in June. We have seen increases in April and May or particularly June was a very, very high month of increases for us. So, the visibility that we had wasn't quite as -- as open as we would have liked.

Okay. And on Fuel Specialties, I think you mentioned that the second half would be more difficult. Are you having any pushback in terms of getting pricing there?

I think in Fuel Specialties we have consistently said that the full year expectation is within the range and we haven't changed that despite some push on that based on the excellent first half of the year.

In some areas, there is some increasing competition in certain product ranges, which is making it more difficult for us to put prices through. But overall, I think that business is doing an exceptional job of being able to handle that. And with a few exceptions, we believe that has something that we can continue to do.

Okay, thank you.

You are welcome.

Thank you. We will take our next question from Jeff Zekauskas with JPMorgan. Please go ahead.

Hi, good day.

Hi, Jeff.

Good morning, Jeff.

In terms of the raw material disruptions you had in Fuel Specialties, how much did that hurt your volumes in the quarter and is that fixed?

Jeff, this is Ian. One of the things you will see in Fuel Specialties this quarter is about 3 percentage point drop off in our volumes. That is mainly due to some supply issues we have had with certain raw materials. We're [on with] fixing that, it's hurt our margins and it's hurt our ability to sell. There is no issue with demand in the medium term. I am not going to tell you which raw material that is because that's obviously a sensitive issue, which we are looking to resolve either with our current supplier or other suppliers.

So it's not yet resolved, so there may be a volume penalty in the third quarter? Is that what you are saying?

I think in the third quarter, Jeff, we will see some margin impacts and some potential volume issues. We have [built] some strategic stock in this area, but we remain on [resolve to completely] on this issue.

Okay. In the Active Chemical area, which you are going to put together with Fuel Specialties, you spoke of cost reduction efforts and restructuring efforts, how much do you expect to save and how much will that cost you?

We booked in the second quarter restructuring charge, which principally taking care of the amount of researching we expect to see and that about $1 million, and the people related to that, have already left the business.

But the principal reason for doing this, Jeff, was not only in terms of a cost reduction per se, it was more about leveraging the skills and the expertise and the performance that we have seen in our Fuel Specialties area.

They have done a great job over the last few years in terms managing pricing, running their business on a regional basis and have been extremely customer focused. And that's something that I felt was needed in greater degree within Active Chemicals, and I think the team that we have got within that business can handle it and we will start to see the improvements overall across Innospec.

I guess, lastly in Octane Additives, your gross margin was pretty good this quarter. It was maybe 52% or so, which was up about 1,200 basis points from the first quarter when your sales were much higher. So, what was it about this quarter that was so profitable? Is it -- does it have something to do with the mix or with your inventory costs? What -- what's there?

Jeff, absolutely right, when you said the mix. We have a number of countries, which we sell to and some are more profitable than the others. This quarter, it was just a more profitable mix going through for us than same quarter last year.

There wasn't, at least as I understood your comments, there wasn't much change in average pricing. Is that something that will be true for the year or is that something that has to do with the mix in this quarter?

We have had some [over due] pricing changes, Jeff, but that's more [masked] by the mix. [We've had some] products increases year-over-year, but yes, the mix has played the biggest part in that.

Okay, thank you very much.

Thanks, Jeff.

Thank you. (OPERATOR INSTRUCTIONS). We will now take a question from David Wilson of Smith Barney. Please go ahead.

Good morning, guys.

Hi, David.

Hi, David.

Could you give me an idea of what your [avgas] volumes are and what pricing is doing in that market?

David, this is Paul. We don't know in which state the actual avgas volume is, the same terms of actual tonnage. All I would say, it's a much greatest part of what we are selling [is actually valid] at these states than they used to be. And as you know, those volumes get reported in our Fuel Specialties business.

In terms of pricing, where we can we've looked at increases year-over-year and we will continue to look at that but there are couple of areas where that's a little bit more challenging, but we are looking to try and manage the margins as much as we can.

The inventory build, you said is any of that in the [TEL] of the avgas markets?

David, this is Ian. Some of it is in the TEL business, and we have taken some opportunities to build some strategic inventory value, yes.

Okay, thanks a lot.

Thank you, David.

(OPERATOR INSTRUCTIONS). As we have no further questions, I would like to turn the call back to you, Mr. Paul Jennings, for any additional or closing remarks.

Thank you, and thank you all for your questions. Now, I would now like to leave you with a few final thoughts. While we are far from satisfied with our overall results for the quarter, it is important to note that the largest business, Fuel Specialties, remains on track with strong year in 2008. We have fine tuned our guidance ranges for both Active Chemicals and Octane Additives, but the adjustments added to a relatively small change in our overall outlook for the year.

In many ways our strategy today remains the same as it was three years ago. We want to continue running our core businesses better and we have clearly set the stage for that with our new integrated Global Specialty Chemicals Organizational Structure.

We continue to believe our ongoing growth businesses in Fuel Specialties and Active Chemicals have strong leadership positions in attractive markets, which we are well positioned to leverage in the years ahead. We are steadily increasing the understanding and visibility of the Company, and by improving our [technical] management through our share repurchases and steady growth in our cash dividend.

If you have any further questions, please give Kate, Ian, Patrick or myself a call. If we don't hear from you in the meantime, we will look forward to sharing our third quarter results with you at that time. Thanks again for being with us on the call today.

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