Innospec Inc (IOSP) 2010 Q2 法說會逐字稿

Good day and welcome to the Innospec, Inc. second-quarter 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, Vice President and General Counsel. Please go ahead, sir.

Thank you. Good day, everyone. My name is David Williams and I am Vice President and General Counsel and Chief Compliance Officer at Innospec. Thanks for joining our second-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 June 30, 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 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 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. With that, I will turn it over to you, Patrick.

Thank you, David, and thanks, everyone, for joining 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, we are very pleased with our results for the second quarter. We reported strong increases in both GAAP and adjusted EPS. If we exclude the special items, our EPS more than doubled from a year ago. We are especially pleased that the increases were virtually across the board. All three of our business segments delivered double-digit percentage increases in both sales and operating income.

In Fuel Specialties, our largest business, the segment sales were up 13% and operating income increased 21% even though the operating environment in its key end markets remain challenging. Increasing raw material costs are pressuring gross margins. However, with the exception of EMEA, fuel demand is showing some signs of growth. Against this backdrop, our Fuel Specialties business continues to significantly outperform its industry peers.

Active Chemicals reported another strong quarter even though it's beginning to face much tougher year-on-year comparisons. The segment's revenues increased 20% and the operating income rose 29% from a year ago.

In Octane Additives, revenues for the quarter were approximately double the level from a year ago and operating income even excluding charges last year was up dramatically. Overall, our GAAP results showed diluted EPS of $0.48, four times the $0.12 we reported a year ago. We took a significant hit in Q2 this year from foreign exchange losses, which was partially offset by the adjustment -- the adjustment to some United Kingdom income tax provisions.

Backing out these and other special items from years, our adjusted earnings per share for the quarter were $0.66 compared with $0.32 a year ago. We consider this an exceptional performance in the current global economic environment.

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, total revenues for the quarter were $168.4 million, a 23% increase from $137 million in last year's second quarter. The overall gross profit percentage was 32.5%, up 2.7 percentage points reflecting significantly higher margins in Octane Additives. Gross margins were down slightly in both Fuel Specialties and Active Chemicals.

As Patrick noted, our GAAP earnings per diluted share were $0.48, but that included $0.31 in foreign exchange losses and the $0.20 positive adjustment related to the settlement of the United Kingdom tax matter. We also booked a $0.06 pension charge and a $0.01 restructuring charge.

Overall, the net reduction in our second-quarter EPS from these items was $0.18. A year ago, our earnings of $0.12 per share included a net total of $0.20 in special items. Excluding the special items in both years, our adjusted EPS was $0.66, more than double the $0.32 a year ago, an excellent result under the circumstances.

Turning to slide 7, in Fuel Specialties, revenues increased 13% and unit volume was up a remarkable 30%. Selling prices and product mix reduced sales by approximately 12% while foreign exchange translation subtracted another 5%.

By region, revenues increased 7% in the Americas and 6% in the EMEA region. In the smaller Asia Pacific region, sales were up 90% thanks to significantly higher sales across all of its product lines.

In our [Avtel] aviation fuel business, sales were down 31%, reflecting a shift in the timing of shipments although margins were up sharply. However, as Patrick noted, fuel specialties gross margins were generally under pressure in the quarter, reflecting higher raw material costs and more intense price competition this year. In total, the segment's gross margin was 31.1%, down 1.3 percentage points from a year ago. Operating income of $17.1 million was up 21% from last year's second quarter.

With our track record of proven performance in this business, we are increasingly confident that Fuel Specialties can continue to perform relatively well in the second half even if the industry environment does not improve significantly.

Moving on to slide 8, our Active Chemicals business delivered another strong quarter. Revenues were up 20% with strength in polymers, fragrance ingredients, and personal care driving the growth. Unit volume was up 5%. A richer price and product mix contributed 17%, and currency effects reduced sales by about 2%.

By region, revenues increased 30% in the Americas, 15% in the EMEA, and 5% in the Asia-Pacific region. Revenues in the Americas again benefited from the introduction earlier this year of our new Iselux surfactant, which Patrick will address later in greater detail. This segment's gross profit percentage for the quarter was 21.8%, down 0.2 percentage points from a year ago.

We are encouraged that we have been able to stabilize Active Chemicals margins at these relatively high levels. Operating income for the quarter was $3.6 million, a 29% increase from $2.8 million a year ago.

Turning to slide 9, in Octane Additives, revenues for the second quarter were $26.1 million, approximately double the revenues of $13 million in both this year's first quarter and the second quarter a year ago. The increase was primarily due to a 93% unit volume gain from last year's second quarter.

The gross profit percentage of 53.6% was also up sharply from 30.5% a year ago, reflecting unit production costs on the increased volume and a more favorable sales mix and currency translation benefits from a primarily sterling cost base in this business.

Operating income for the quarter was $11.6 million, compared with a $3.6 million operating loss a year ago, which included $5.9 million expenses and accruals related to the Oil for Food and FCPA investigations. Even excluding those items, operating income in Octane Additives was up sharply from a year ago. This performance of this segment has significantly exceeded our expectations in 2010 although there remains no doubt that longer term the business will gradually decline.

Moving on to slide 10, corporate costs for the quarter were $4.8 million, unchanged from a year ago. We also incurred a pension charge of $2.1 million, which is broadly the quarterly run rate we expect going forward.

As noted earlier, we had foreign exchange losses of $10.8 million pretax, $7.7 million after tax compared with a slight gain a year ago. The key driver here is the increased losses on foreign currency forward contracts.

Our reported tax rate for the quarter was 7%, but that includes the $5 million benefit from the settlement of tax matters in the United Kingdom. Backing that out, our tax rate was 26.4% compared with 36.2% a year ago. We now estimate the tax rate for the full year will be about 26% excluding the benefits in Q2.

Turning to slide 11, cash flow from operations was strong in the second quarter. We generated $10 million in free cash flow even after paying $10 million in fines related to the Oil for Food and FCPA matters and after $2.2 million in capital expenditures.

As of June 30, we had cash and cash equivalents of $77 million, which exceeded our total debt by $30 million. However, as we have stated previously, we expect cash outflows in future quarters as we rebuild working capital to more normal levels, increase our capital expenditures, and make additional cash payments related to the recent legal settlements.

During the second quarter, we were able to reduce the reported pension liability in our balance sheet by $19.4 million from the first-quarter level. This reduction reflects our management program to control and contain this future liability.

And now I will turn it back over to Patrick for some concluding comments.

Thank you, Ian. Moving to slide 13 in the presentation, I have a few more points and then we'll take your questions.

I would like to reiterate that we are extremely pleased with our second-quarter results. While we are still not prepared to provide specific guidance, I can say that directionally we feel very confident about the outlook of all three of our business segments over the near term. While market conditions remain challenging in Fuel Specialties, we see no reason why our team won't continue outperforming its industry peers.

As we have stated before, we believe the combination of our exceptional people, our continued product development efforts, and our overall approach to meeting customer needs is very powerful. Along those lines, I would point out that the Company's R&D spending for the first half of 2010 was up 18% from a year ago. So despite the margin pressures we are experiencing and soft demand anemia, we believe Fuel Specialties is likely to continue performing relatively well in the second half.

We are also increasingly optimistic about sustaining the turnaround we have achieved in Active Chemicals. As Ian noted, Octane Additives has performed above our expectations this year and may well continue doing so over the quarters immediately ahead.

I wanted to provide you a brief update today on Iselux, Active Chemicals' exciting new part in the surfactant area which we officially launched earlier this year. As you may recall, Iselux is a very mild surfactant that can be used in shampoos, body and facial washes, bath foams and is clearly differentiated in the marketplace. Several major customers are now in the process of launching new products incorporating Iselux and we continue to believe it has potential to become one of Active Chemicals biggest and most profitable product in the years ahead.

Now that we have put the Oil for Food and FCPA matters behind us, we've begun looking aggressively at a variety of possible strategic alliances and acquisition opportunities. As our second-quarter financials clearly demonstrate, our balance sheet is strong and highly liquid and we generated $10 million in free cash and even after paying $10 million in fines to the various government bodies during the quarter. So there is no doubt that we have more than ample resources to grow the business both internally and through strategic acquisitions in the years ahead.

One final note. We are planning to step up our investor relations program significantly in the second half and expect to be scheduling meetings in the US and United Kingdom during the fourth quarter.

With that, I will turn the call back over to the operator and we will be happy to take any of your questions you may have.

(Operator Instructions) Jeff Zekauskas, JPMorgan.

This is Olga Guteneva for Jeff Zekauskas. How are you? So a couple of questions, on Fuel Specialties, why is it that you had this significant volume improvement in the second quarter? Could you explain maybe some of the product were up significantly?

Yes, it's Patrick. Let me just give you a quick update. In 2009, we put a renewed focus obviously into the [RNT] programs as well as the growth markets which we considered at that time South America and obviously India and China. You've seen Asia-Pacific numbers. They grew 90% in the quarter on topline sales and that's obviously with the deregulation in the marketplace as well as just general market trends.

We are very confident that the growth has been across all product lines. We can't necessarily pinpoint one product in general and that's just due to the fact again that we've renewed our focus in those areas. We're very well-positioned to potentially put in new products into that marketplace.

So you mentioned that aviation on (inaudible) was down in the quarter, so how much it was down and excluding this, what's the -- what was the improvement in other segments -- other product groups?

This is Ian. Our upscale revenues decreased due to lower volumes in the quarter and volumes were down about 44% on last year. And that is primarily due to the timing of shipments and was offset partly by about 13% increase in richer price and product mix. Over the medium term, we haven't really changed our view on the Avtel market. It remains stable and sales remain roundabout $25 million to $30 million per annum.

However due to the small number of customers that remain in that market, the timelier shipments and the sales can fluctuate significantly from quarter to quarter and from year to year. That's primarily the downside in the business. Obviously we were pleased with the rest of the regions and the rest of -- how the product performed across the quarter in Fuel Specialties.

Okay, so if we look at the month of July and excluding the Avtel, was it different from the second quarter? Were you seeing the same trends? How is it developing so far?

Olga, it's Ian again. I would say it's pretty stable with what we saw in quarter two so far.

And in terms of raw materials, are you seeing upward trend, downward trend? Is it relatively stable?

This is Patrick. We are generally seeing a small upward trend and albeit we are trying to manage the price increases back to the customer base, we just have to keep in light that the consumers, the ultimate individual who takes on the price increase, we have to work with our customer base to make sure that we are all competitive in all phases.

There is a general price increase trend on all base raw materials but we are generally able to pass those onto the consumer.

Okay, so in general if you look at the first half of the year and your outlook for the second half, in terms of the profits, do you think you can do better than in the first half? Worse or the same?

We feel very confident that moving forward that you are going to see similar type profits. We are very confident that the way we positioned our business and obviously with 36% of our revenue coming from new products over the last five years, that we generally positioned ourselves extremely well for the remainder of 2010.

Okay, that's great. Switching quickly to Octane Additives, are you -- have you adjusted the production to meet the higher demand or you have enough inventories? How does it work?

Yes, Olga, this is Ian again. We've had to increase our production levels on the Ellesmere Port site in the United Kingdom to meet the current levels of [more] gas demand.

So how flexible are you in terms of change in the production levels? How long does it take to increase or add the production?

Obviously we have a sales and operational planning process and we need a fair amount of time to make sure that we've got all the raw materials in place, we've got all the logistics in place in terms of containers and the likes so that we can ship final product. But we do have some flexibility about moving from a five-day working week to a seven-day working week and a 24/7 operation. We can do that over a shorter timeframe, but it certainly helps us generate a higher margin in the Octane Additives business by putting all volume through the plant. It's produced a lower unit cost for us to sell through to the customer.

Right, and the last one, if I may, for your pension expense, could you walk me through the relationship between the reduced liability and the reduced future pension expense? Are they related or are these two separate matters?

Yes. They are related, Olga. I think there's a couple of things I would say here. As we previously discussed, we've as a Company -- we have commenced a program of actions that contain and where possible contract our pension liabilities. And you will recollect that in the first quarter of this year, we closed the plant to future accrual.

In the second quarter, we have amended the pension plan again and that is to allow the slightly change -- a slight change in the way pensions receive their future increases. To now, we see static increases for a higher initial pension. And that amendment has had the benefit of providing us with certainty and being able to enable us to reduce the liabilities, the financial benefit of which is that we have been able to reduce the liabilities on the balance sheet. And on a go-forward basis, we believe that our $2.1 million per quarter charge to the income statement will be the level that we will stay at.

In saying all that, we've got plans in place for future adjustments. Pension is a long-term issue and we've got long-term plans to address that issue as well.

So correct me if I'm wrong. So this liability reduction did not affect the cash flow, meaning that was just on -- like on the balance sheet, that was the adjustment? Or you did some one-time payment?

No, there was no cash involved, Olga. The $19 million reduction in the liability was a non-cash event for us.

Okay, great. Thank you.

Gregg Hillman, First Wilshire Securities Management.

Good morning, gentlemen. Could you talk about the diesel fuel consumption in some of your various markets, what percentage it was down or up over a year ago for the quarter?

No problem, Gregg. This is Patrick Williams. If you look at typical market trends that we fall or obviously refine our utilization rates, fuel consumption and demand, vessel movement, and what we have seen from 2009 to 2010 is the general obviously upward trend in Asia-Pacific where utilization rates, refineries are running probably in the mid to low 90s.

On the US from 2009 to 2010, we've seen refinery utilization rates go from about 80% to 85% 2009 over the period to 2010 to date is upwards to about the 90 -- low 90 percentile range. So what you're seeing in general is consumption rates are up in Asia-Pacific and holding very well. Generally trending downward in Europe, Middle East, and Africa. In the US, we're starting to see some slow signs of growth in the US.

We would like to see generally three quarters -- we don't look at just GDP growth but three quarters submarket trend growth that we follow to really figure out if the market is trending upward and we are coming out of a recessionary period. We are still not comfortable that we are out of it yet, but we are seeing signs of life and we just hope the trends continue for the third and fourth quarter.

Okay, great. Patrick, in terms of the Iselux, can you just talk about the plant utilization, where you are at in terms of plant or how many shifts you are running and when a new line is going to come on?

Yes, no problem, Gregg. We just instituted actually activity at the plant to add another reactor. It's called the R8 reactor, strictly to make Iselux -- so that we will have two reactors making the Iselux product. In addition to making the R8, we have put in piping as well as cement foundation to -- for the R9 reactor. So as a time constraints, if we get into it, we can get the R9 reactor up and running fairly quick.

We are very cognizant that some of the customers' demand could be a lot larger than we anticipated. But this is -- when you look at personal care, the launches are -- take a lot longer. You don't know how the consumer takes the product on to really determine how much volume you need. But we worked very closer -- very close with our customers to determine when we should launch the R9 reactor.

Speaking of the launch of these products, have any of these products been launched with a lot of marketing effort behind them? Or is that going to happen maybe this fall?

It is launched. If you recall, though, it is just the -- the Iselux is maybe 10% to 15% of a finished product that sits on a shelf. So we don't go actually to the retail markets. We sell into companies who take it to the retail markets. We did do a launch at several conferences with a booth and obviously we have a lot of marketing material, and a lot of salespeople on this product along with technical support.

So it has been fully launched into the market. It just takes time before the consumer takes it on, before the customer takes it on.

And can you give me an example of a consumer product which contains Iselux?

As a matter of fact, we just had some shampoo and some body washes in here the other day but you are looking at -- Kirkland has a product that's out at Costco. If you go to Costco, you will see it. If you pull the Kirkland product out of Costco on a shelf, it's typically the second ingredient. And you will see it on there.

Okay, and is Procter & Gamble -- is it in the P&G products that are out there?

Not quite yet. It's ongoing. It's in their technical hands right now to see where they are going to product launch the product, whether its baby shampoos or whether its body gels or adult shampoos.

Okay. And, Ian, could you just review the payment for the settlement again that have been made today and what's due to be paid?

Yes, in 2010, we are due to pay $20 million. We made the first $10 million payments in the first quarter and we will make the second $10 payment over quarter three and quarter four this year.

Okay, and then in subsequent years, what would be due?

I will have to go from memory here, Gregg. Of the $40.2 million, I think we've got about $10 million next year and about $10 million in '12.

And that will finish it?

That will finish it, yes.

Okay, that's great. Thank you very much.

(Operator Instructions) Gregg Hillman, First Wilshire Securities Management.

Could you just talk about the human resource area a little bit? The personnel changes that you have made in the last -- I don't know -- six months and why are they important for the Company?

Yes, Gregg, it's Patrick here. If you recall back in -- late 2008, 2009, we took over management of the Active Chemicals Group. What we did is took a lot of the management skills that were in the Fuel Specialties arena that could take the business model, that were used to the business model to lump it on top of Active Chemicals. Therefore, you could back into how we run RNT, how we bring RNT to the market, how we cooperate with each other.

So we took some current managers that were in Fuel Specialties. We put them into Active Chemicals and we've seen the net effects of that obviously through the numbers. I think additionally our belief is that we've probably got the most solid management team in the industry.

Additionally to that, we have added new Board members, a gentleman by the name of Bob Paller, who is an attorney out of Atlanta, who has a lot of experience in M&A, to the Board. Additionally we just added another new Board member by the name of Bud Blackmore, who was a vice president and an officer at Sinclair, which is a refinery on the west.

And what we've really done is revamped the Board to now more of a growth Board in changing of the mark and the change of how our companies made changes over the last year. I think coming out of the investigation, we obviously had to do a lot to hang onto our management team and they really fought hard to hang onto the market share that we have.

But the general -- those are probably the general management changes that we have made and restructured. We have obviously done some restructuring internally as well on the way we run our business and how we tie it to the market, but that's probably the ones that are most significant that you would probably see out in the open market.

Okay, and just finally your program to support like the three Ps, are you going to do anything special in terms of your management team to support those customers?

Absolutely, and it's not anything different than we have done in the last two years. It's technical support along with marketing support and looking at new products and innovation, looking at future fuels. We do a thing called 2025. It's Vision 2025 not only for Fuel Specialties but for Active Chemicals and it's really looking at new engine technology, new regulatory and legislation coming down, and what the new field trends are going -- how the new fuel trends are going to be. And we address our RNT according to that program. And we share that with the customer base.

And speaking of regulations, I know that you had a product for the new diesel engines, new -- can you tell me about how that's going?

Yes, it's going as it was in the first quarter. We've had good sells in the HPFI, HSDI arena. The product brand is called ECOCLEAN and it's going as anticipated.

Okay, thanks very much.

(Operator Instructions) At this time, as we have no further questions, I would like to hand the call back over to our host, Mr. Patrick Williams, for any additional or closing remarks.

Thank you for your questions. I have just a few final remarks. As I suggested earlier, I am very pleased with the Company's performance in the second quarter and with our near-term outlook going forward, all three of our business segments performed extremely well in the quarter and I think that is a tribute to the strength of our global management teams and the fundamental soundness of our business model in these challenging times.

Our long-term strategy remains very much intact. We continue to believe that our core ongoing businesses in Fuel Specialties and Active Chemicals are well-positioned in their markets to drive significant growth and returns for our shareholders both internally and through potential strategic acquisitions.

Quite simply, we have a very sound platform to build upon as well as the people, flexibility, and financial resources to deliver against the future promise.

If you have any follow-up questions, please give us a call. And if we don't hear from you in the meantime, we will look forward to sharing our third-quarter results with you in a few months. Thanks again for joining us on the call today and goodbye.

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