Innospec Inc (IOSP) 2010 Q1 法說會逐字稿

Good day, and welcome to the Innospec First Quarter 2010 Results Conference Call. For your information, today's conference is being recorded. At this time, I would like to turn the conference over to Mr. David Williams. Please go ahead, sir.

Thank you, and good day, everyone. My name's David Williams, I'm Vice President, General Counsel, and Chief Compliance Officer at Innospec. Thanks for joining our First Quarter 2010 Financial Results conference call. Today's call is being recorded.

As you know, late yesterday we reported our financial results for the quarter ended March 31, 2010. The press release is posted on the Company's website, 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 everyone 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 discussions 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 us today from Innospec are Patrick Williams, President and Chief Executive Officer, and Ian Cleminson, Executive Vice President and Chief Financial Officer. And with that, I will turn it over to you, Patrick.

Thank you David, and thanks, everyone, for taking the time to join us today. Turning to slide 4 in the presentation, I have a few summary comments before Ian takes us through the numbers in greater detail.

Overall, in view of headwinds we continue to face from the weak fuel markets, we are pleased with our results for the first quarter. In Fuel Specialties, we are up against a very tough comparison with last year when rapidly-declining raw material costs enabled us to deliver an unusually high gross margin. This year with margins in a more normal range, our operating income declined 19%. The good news is that we achieved 5% unit volume growth in this environment, indicating that we are continuing to grow our market share in this key business.

Active Chemicals reported its best ever quarter in operating income terms, with strong sales across the board as well as improved gross margins. The segment's revenues for the quarter increased a remarkable 28% on an 11% gain in unit volume and operating income more than tripled from a year ago. In Octane Additives, revenues and profits rebounded nicely from unusually low levels a year ago. Overall, our GAAP results show EPS of $0.30 per diluted share, a 15% increase from $0.26 in last year's first quarter. The results this year include a $0.24 restructuring charge related to changes in our United Kingdom pension plan as well as our ongoing quarterly pension charge of $0.12 per share, which as expected was up significantly from a year ago. The results also include a number of other special items, which Ian will review in detail in a few minutes.

But, if you back them all out, our adjusted earnings per share for the quarter were $0.67, on par with last year, which is a very good performance.

One of our major highlights of the quarter was our successful completion of the settlement negotiations with the US and United Kingdom authorities regarding the investigations into the Company's actions under the United Nations Oil for Food Program and Foreign Corrupt Practices Act. As we anticipated, the final settlement is up to $40.2 million, which we have already fully accrued in the third and fourth quarters of 2009. I'll have more to say about this later, but we are obviously extremely pleased to be able to put this chapter in the Company's history behind us, and to turn our full attention back to building a business and shareholder value.

With that, I'll turn the call over to Ian Cleminson, our Chief Financial Officer.

Thank you, Patrick. Moving to Slide 6 in the presentation, on a consolidated basis, revenues for the quarter of $163.5 million were up 10% from $148.1 million a year ago. The overall gross profit percentage was 31.9%, down two percentage points, reflecting lower margins at both Fuel Specialties and Octane Additives, partially offset by further margin improvements at Active Chemicals.

As Patrick noted, our GAAP earnings per diluted share were $0.30, but that included the $0.24 restructuring charge and $0.12 pension charge he mentioned. We also booked a $0.12 charge to account for the expected costs of our new external compliance monitor, which was offset by a $0.12 gain from adjustments to our previous Oil For Food FCPA settlement accruals. In addition, we booked $0.01 in foreign exchange losses.

Overall, the net reduction in our first quarter earnings per share from these items was $0.37. A year ago, our earnings of $0.26 per share included a $0.20 charge related to the investigations, $0.20 in foreign exchange losses, a $0.04 restructuring charge, and a $0.04 pension charge, which were partially offset by a $0.07 gain on forfeited stock options. All told, the special items a year ago netted out to $0.41 per share.

Excluding the special actions in both years, our adjusted EPS was $0.67 in both years, which is a very good performance under the circumstances.

Turning to slide 7, in Fuel Specialties, revenues were down 1% but unit volume was actually increased by 5 percentage points. Selling prices were under considerable pressure, falling an average of 9% from a year ago, principally in the Americas and EMEA, which was mostly offset by the volume gains and positive currency effects of 3%.

By region, revenues declined 12% in the Americas, but were up 1% in the EMEA region and 33% in the Asia-Pacific region, which is benefiting from China's strong GDP growth and is seeing increased sales across most of its product lines.

As Patrick noted, Fuel Specialties gross margin had been unusually high a year ago, up 37.4% as we were initially able to hold pricing relatively firm while raw material costs declined rapidly. This year, with pricing down significantly our gross margin is in a more normal range, at 33.7%.

Overall, the segment's operating income was $22.1 million, down 19% from last year's first quarter. So far, diesel fuel demand has not improved significantly and remains below pre-recession levels across most of our key markets, particularly in the Americas where we find our utilization rates are in the mid-80s. So, the outlook for the balance of the year remains challenging in Fuel Specialties, until we return to more normalized levels.

Moving on to slide 8, our Active Chemicals business delivered a record quarter for operating income. Revenues were up 28% from a relatively weak period a year ago, but the gains were broad-based with strength in polymers, personal care, fragrances, and our household, industrial and institutional business. Unit volume was up 11%. Higher prices contributed 11% and currency effects accounted for the remaining 6%.

By region, revenues were up 15% in the Americas, 36% in EMEA, and 42% in the Asia Pacific region. Revenues in the Americas benefited in part from the introduction of our new Iselux surfactant which Patrick will discuss later in greater detail.

The gross profit percentage in Active Chemicals was 21.9%, up 4.5 points from 17.4% a year ago. The large improvement primarily reflects increased prices, production efficiencies, and a richer sales mix. The segment's operating income was $4.1 million, up sharply from $1.2 million a year ago.

Turning to slide 9, in Octane Additives, revenues for the quarter were $13.3 million, more than double the $5.3 million a year ago which was affected by the timing of certain shipments. While the gross profit percentage of 45.1% was about 6 points below a year ago, it was still relatively strong and above our expectations, reflecting a more favorable sales mix and efficiencies from higher production levels.

The reported operating income at $6.7 million includes a $3 million adjustment to the settlement accruals compared to the $5.8 million operating loss a year ago which included $7 million in expenses and accruals related to the Oil for Food and FCPA investigations.

Excluding these items, Octane Additives generated a solid operating income of $3.7 million, more than triple the $1.2 million a year ago.

Moving on to slide 10, corporate costs for the quarter were $9 million, compared with $1 million a year ago. However, this year's first quarter includes a $3.9 million charge that expected total costs over the next three years of our new compliance monitor, while the year earlier period included a $2.4 million gain from the forfeiture of stock options by our former CEO. Excluding these items, corporate costs increased to $5.1 million from $3.4 million a year ago, partly reflecting the strength of the British Pound.

The quarter's results also included a non-cash $8.2 million pre-tax restructuring charge related to our decision to close our United Kingdom Defined Benefit Pension Plan to future service accrual, and to replace it with a defined contribution plan.

In addition, as expected, we reported a significant increase in our regular quarterly charge for pensions to $3.8 million this year from $1.5 million in last year's first quarter. We recorded an $0.2 million after-tax foreign exchange loss in the first quarter, a significant reduction from $4.9 million a year ago.

The effective tax rate for the quarter was 26%, compared to 32.6% a year ago, and reflects our expected tax rates for the full year.

Turning to slide 11, cash flow was positive in the first quarter, as we generated $7 million in free cash flow net of $1.4 million in capital expenditures. This reflects our continued strong operating income, partially offset by increased working capital requirements as expected. As of March 31, we have cash and cash equivalents of $67.5 million which exceeded our total debts by $22.5 million. However, as we've stated previously, we expect cash outflows in the future quarters as we rebuild working capital to more normal levels, increase our capital expenditures and pension contributions, and begin making cash payments related to our recent legal settlements.

And now, I'll turn it back over to Patrick for some concluding comments.

Thank you, Ian. Moving on to slide 13, I'd like to make a few more points before we take your questions. We're pleased with our first quarter results, and encouraged by recent increases in refinery utilization rates which are critical for our biggest business, Fuel Specialties. However, demand for diesel fuel on average is still down from pre-recession levels across our global markets. So, at this point we feel Fuel Specialties will be doing very well just to match its 2009 numbers this year.

On the other hand, in Active Chemicals, given the broad-base strength of sales margins during the first quarter, our outlook for the balance of the year has clearly improved over the last few months. We have also raised our internal near-term expectations for octane additives, although nothing has fundamentally changed in their longer term outlook for this business which will continue to gradually decline over time.

Active Chemicals results for the first quarter included good initial orders in the Americas for Iselux, our new breakthrough product in the surfactant area. Iselux is a very mild surfactant that can be used in shampoos, body and facial washes, and bath foams. It provides a dense, luxurious foam and elegant after-feel with gentle yet thorough cleansing, and outstanding rinsability. We believe Iselux has the potential to become one of Active Chemical's most important and profitable products in the years ahead.

With regard to the introduction of the new products, we remain very focused on delivering innovative R&D programs and new product partnerships similar to our recent Huntsman collaboration.

As I stated earlier, we were very pleased to arrive at a final settlement with the US, United Kingdom authorities regarding the Oil For Food and FCPA matters during the first quarter. The financial terms of the settlement were in line with our previous expectations calling for total payments of up to $40.2 million over a four-year period, of which we have just paid $10 million in April.

We expect to pay a further $10 million over the next 12 months, and the balance over the remaining periods. Full details of the settlement are available in our 10-Q, which we will file with the SEC today.

We believe our successful resolution of these matters was due in part to our extensive cooperation with the investigations as well as our establishment of an enhanced compliance program which will include an external compliance monitor for at least three years. The terms of the settlement provide for substantial cash payments but still leave us with the resources and flexibility to grow the business in the years ahead. And, those of us in Senior Management are pleased to be finished with negotiations and to now turn our full attention to executing our long term growth strategy.

Along those lines, it is reasonable to assume that we will be pursuing strategic alliances and small acquisitions that fit well with our existing growth business in Fuel Specialties and Active Chemicals. But, as we said previously, any deal we do is going to have to make sense for our shareholders and employees.

Now that we have reached final settlement, it is also reasonable to assume that Innospec Board of Directors would eventually take a closer look at options such as reinstating dividend payments and/or authorizing additional share repurchases. However, those decisions will be strictly up to the Board and it would not be appropriate for us to discuss them further here today. And with that, I'll turn the call back over to the operator, and we'd be happy to take any questions you may have.

Thank you. (Operator Instructions) And we have our first question from [Jonathan Yorst] from Paradigm, please go ahead.

Hi, guys. Can I assume that the legal expenses that have been associated, that have been going on for so long and that have been associated with the investigations, will be tapering off and ending next quarter, or a few quarters from hence?

Hi Jonathan, this is Ian. Yes, that's the correct assumption. We don't expect to incur any more legal and professional fees on a go-forward basis.

Okay, and just a quick question, your-- you have this charge for three years of an outside monitor. Why wouldn't you just expense that as it occurs?

Our accounting policy is to accrue for legal fees, when we committed to them, and as we're committed to the monitor over the next three years we felt it was the right thing to do at this point to accrue it with the next three years' charges, and that's exactly what we've done.

Okay, thank you.

Thank you.

Thank you.

And our next question is from Jeff Zekauskas from JPMorgan, please go ahead, sir.

Good morning, this is Olga Guteneva sitting in for Jeff. Good quarter.

Thank you.

Thank you, Olga.

Yes. So, what was the effect of lower prices in Fuel Specialties on sales in the quarter, and what was the currency effects?

Hi Olga, this is Ian. Yes, I think overall our revenues were down by 1 percentage point, which we feel is a pretty good performance with the backdrop to the economic climate as it is. Of that 1% decline, we actually saw positive impacts of volume by 5%, and we actually saw currency effects positive by 3 and a negative effect from pricing and sales mix of 9.

Okay. So, could you discuss the raw material trends in Fuel Specialties, and do you think you can raise prices, and how it will all affect the gross margins? Just work us through your thinking?

Sure, it's Patrick, here. If you-- obviously, if you're following base oil and you're following crude and nat gas, nat gas has had a trend down, crude oil has had a trend up, and you base off -- some of our products are based off crude oil and base oil. So, there has been a natural trend of base oils moving upwards, primarily in the first quarter. We haven't really seen a large increase in Q3 and Q4 2009, but we have in 2010. Obviously we've done a very good job of maintaining market prices, albeit this is a very difficult environment to raise prices onto the consumer. We do it where we can. We're very conscious of our customer base. Obviously, we're all in difficult times, but where we can raise prices and where we have formula-based prices, we do raise them.

The primary issue I have in this market today is that you have a lot of competitors, and this is inherent throughout the chemical industry, where if you're not running at run rates of at least 75% to 78%, on your own facilities, you're losing money. And so, you're seeing a lot of bizarre pricing is probably the best way to put it, in the marketplace just to sustain enough products through your facilities to maintain that asset.

And so, we're just going to have to be cautious of what goes on out in the marketplace and what the consumer can take, but obviously we are trying to pass on price increases where we can. We do see base oil still moving upwards, the trend in probably Q2 and Q3, and then probably baselining at that point looking forward.

So, just to summarize all this, do you think it's reasonable to assume that your gross margin will contract a little bit in the second quarter and probably in the third quarter?

No, I think our gross margins are pretty steady where they are right now.

Um-hmm, okay. And can you talk about the effect of weaker Euro on your financial results this year? Should the Euro stay where it is now, or fall further, will you see any effect?

Yes Olga, this is Ian again. We consider our trading business to be naturally hedged, and what I mean by that is that the trading arms of Fuel Specialties, Active Chemicals and Octane Additives don't tend to be impacted by movements in exchange rates. We have natural hedges in terms of how our currency flows through that business. The area where we do see some disconnect is in our corporate costs, which tend mainly to be Sterling related, so we do tend to see some increases there if Sterling moves.

What we do is, we actually forward-hedge our currency, and we do that so that we can actually maintain our margins and keep that volatility out of our trading. So, where you see exchange gains and losses are in our other income line, this quarter it was a small loss. That's because we managed to hedge things out in a natural way, but the volatility that you'll see will come through that line where we have to translate Euro and Sterling balance sheets, and also we have to retranslate foreign currency contracts. So, on the trading side, we shouldn't see any impacts. But on the other income side, we might see some volatility going through that line.

Okay, then quickly on Active Chemicals, so you had a very strong improvement in this business. Do you think it's sustainable longer-term? I mean, like, where do you see this business going forward, in terms of both top-line growth and sustainability of the gross margin?

Sure Olga, it's Patrick here. If you reflect a little bit back, if you look at 2008 in Active Chemicals, we were actually at a $12 million loss. If you look at 2009, we were a $12 million gain in operating income, so a $24 million difference between 2008 and 2009. Obviously, 2010 is starting off in the same manner, very positive. We, with the new technologies that we've brought to the marketplace, I think obviously with the new Iselux that we've already previously announced prior to this conference call, we feel very confident that Active Chemicals can remain on the trend that we've had in the first quarter. Not only from a profit margin standpoint, but also from a growth standpoint.

I think one of the things that we had to do with the base business in 2008 is really fix the foundation of the business, and we have done that, and we're now just building upon that foundation and tying [R&T] into the sales, to the salesmen has really fit our model and portfolio very well. We will look at strategic acquisitions in that area, whether it's a product or whether it's technology, as well as Fuel Specialties. But, we do feel confident in Active Chemicals that we can produce similar numbers the next three quarters.

Okay, thank you, and the other, just-- question, so why is it that the CapEx was so low in the quarter? And, do you think you are going to spend at this level for the rest of the year?

Yes Olga, this is Ian again. Yes, we didn't get off to a real quick start in some of our projects this year. I know that both Patrick and myself have signed off on an awful lot of expenditure in the last number of weeks, so we expect that, the capital expenditures, to accelerate into the second quarter. We've already announced the investments that we're making into our Iselux plant in North Carolina, and that work has already started. So, we're confident that the number that we put out there at the beginning of the year of roundabout $20 million, could well be achievable. Obviously, we'll revisit that from quarter to quarter with you as well.

Okay, thanks very much.

Thanks, Olga.

(Operator Instructions) And we'll take our next question from Gregg Hillman from First Wilshire Securities, please go ahead.

Yes, good morning.

Good morning, Gregg.

Good morning, Gregg.

Ian, can you talk about the restructuring charge, the $6.2 million, what the components of that were?

Yes, that was all to do with the closure of our UK Defined Benefit Pension Scheme. We closed it on the 31st of March this year, and one of the effects of that was a change in the actuarial assumptions round the scheme. So, we had to take a restructuring charge, which is non-cash, it's one-off, $8.3 million before tax, and you won't be seeing that charge again.

Okay. And then, and then going back to the Iselux product, in terms of the ultimate market size, do you have any idea how high is up, for Iselux?

Gregg, obviously that's very sensitive information, but if you look at introduction of new products in the active chemical sector, it's typically two to three times from a length of time from introduction to commercialization that it is on the field specialties side, so it's hard to really look at the size of the market. We have an idea, and when we originally took off on this venture, it was a lot smaller than we anticipated. Now that we've got our hands around Iselux, and the point of entry into the market, it is probably three or four-fold of what we originally anticipated. And as we develop the programs, as we look at where it could go in as a primary or secondary surfactant, that market, it just opens up even more.

So, I think we will have a better feel, Greg, probably Q4 as to the size of the market, but it is substantial.

Okay, thank you.

(Operator Instructions) We have no further questions. I would like to turn the call back over to you gentlemen for any additional or closing remarks.

Thank you for your questions. And now I'd like to leave you with a few final thoughts.

As I've said, we believe our operating results for the first quarter were very good in light of the ongoing weakness we're facing in the fuel markets. While the year-to-year comparisons of Fuel Specialties are likely to remain challenging throughout 2010, we're starting to see positive signs in fuel demand, and are encouraged by the accelerated momentum we see in Active Chemicals as well as a solid outlook in Octane Additives. Longer term, we continue to believe that our core growth businesses in Fuel Specialties and Active Chemicals have significant growth potential, both internally and through various strategic options. Overall, we have a robust platform that we believe can leverage to drive significant earnings growth and shareholder value in years ahead.

If you have any further questions, please don't hesitate to call us. If we don't hear from you in the meantime, we'll look forward to sharing our second quarter results with you in a few months. Thanks again for being with us on the call today, goodbye and have a great weekend.

Thank you for your participation, Ladies and Gentlemen, you may now disconnect the line.