Innospec Inc (IOSP) 2012 Q2 法說會逐字稿

Good day and welcome to the Innospec Q2 results conference call. For your information, today's conference is being recorded. At this time, I would like to hand the conference over to Mr. David Williams, Vice President, General Counsel and Chief Compliance Officer. Please go ahead.

Thank you and good day, everyone. My name is David Williams and I am Vice President, General Counsel and Chief Compliance Officer at Innospec. Thanks for joining our second-quarter 2012 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, 2012. 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-Q 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 welcome to everyone to Innospec's second-quarter 2012 conference call. Our first quarter momentum carried us well into the second quarter in the face of some very strong and unpredictable headwinds worldwide. Thanks to the diligence of our operating teams throughout the Company and our strong financial management, we performed solidly in Q2. We have paid and will continue to pay close attention to cash management and cost containment in the face of economic uncertainties which has enabled us to maintain a very strong and liquid balance sheet.

Continued positive cash flows from our businesses has enhanced our liquidity as well. We are watching the world economies closely and adjusting our business strategies accordingly. Having said that, our adjusted non-GAAP diluted earnings per share of $0.79 for the second quarter is in line with the financial analyst consensus expectations.

Our overall gross margin was steady at 31.8% at the end of the period and our sales performance across the board was solid by all measures. Year over year, our operating income increased by 7% and I make particular mention of the fact that both net income and EBITDA reported comparisons were down almost exclusively to the pretax $12.2 million swing in foreign exchange currency losses.

Our Fuel Specialties businesses delivered continued sales growth, driven by improved pricing and a richer sales mix, particularly in Avtel sales which were up 29%. Despite our strong competitive pressures in this sector, I am pleased to report that we have maintained our gross margin at or above the 30% threshold on a sequential basis for the third consecutive quarter.

While still comparatively small, our [Oilfield] Specialties business has shown good performance with additional business wins. And we will continue to evaluate external growth opportunities in this area.

You will recall that last year's second quarter was a record for Active Chemicals business. This year we fell short of that record principally and explicitly as a result of lower volumes in the depressed polymers and Fragrance Ingredients in EMEA. Our Active Chemicals business was particularly buoyant in the personal care market.

Certain countries continue to show strong demand for our Octane Additives products and while the future for this business is still unchanged, we continue to record strong margin performance north of 50%.

I will now turn the call over to Ian Cleminson and then return with some comments about our business and our strategies going forward. Then we will take your questions.

Thanks, Patrick. Turning to slide six in the presentation. The Company's total revenues for the second quarter were $178.5 million, a (technical difficulty) [4]% decrease from $186.5 million a year ago. The overall gross margin rose slightly from last year to 31.8% driven by continued strong sales from our higher margin Octane Additives segment and an improved sales and pricing mix in Fuel Specialties.

Our GAAP earnings were $0.65 per share. Under an adjusted basis our earnings per diluted share was $0.79. EBITDA for the quarter was $22.8 million, down from last year, primarily the result of a pretax $12.2 million negative swing in foreign exchange, driven principally by the retranslation of our non-US dollar balance sheet.

Operating income for the quarter was $24.4 million, a 7% increase from the year ago period.

Moving on to slide seven, revenues in Fuel Specialties rose 1% in the second quarter to $114.5 million. The increase was primarily driven by a lower -- driven by a richer sales mix and improved pricing of 8% offset by 3% lower volumes and an unfavorable currency impact of 4%. By region, revenues were down by 3% in the Americas and remained essentially unchanged in EMEA and Asia-Pacific and were up 29% in our Avtel business, which is now operating at our expected levels after a slow first quarter. Margins in this segment has increased by almost 3 percentage points from last year and sequentially continue at the 30% level. Gross profit increased by $3.6 million to $34.7 million and operating income rose to $16.9 million, a 37% increase from a year ago.

Turning to slide eight, revenues in the second quarter in Active Chemicals decreased from last year's record quarter to $44.9 million. A strong pricing on an improved sales mix of 6% was offset by 10% lower volumes and currency effects reduced reported sales by 4%.

By region, revenues increased 11% in the Americas and by 8% in Asia Pacific with a decline of 26% in EMEA driven by the Polymers business. Growth in the Americas and Asia-Pacific was driven by improved volumes in the Personal Care markets. Gross margins increased sequentially by 3 percentage points from the first quarter of 2012 but were down slightly from a strong comparative last year, primarily due to soft demand in the Polymers markets, resulting in competitive pricing.

Active Chemicals' operating income for the quarter was $7.2 million down from $5.1 million in last year's record second quarter but up 20% from the first quarter.

Moving on to slide 9, our Octane Additives business again performed strongly with $19.1 million in revenues, primarily the results of continued high demand although down from a year ago. The segment's gross margin of 51.8% was down slightly from last year's second quarter but remained steady above the 50% level benefiting from the sale of lower cost inventory. Gross profit declined to $9.9 million in the quarter. Segment's operating income for the quarter was $8 million essentially unchanged from $8.1 million in last year's second quarter, which included $3 million pretax of civil complaints related to legal and other professional expenses.

While this segment has significantly exceeded our expectations in the first half of 2012, the second half will not be as strong as the longer term outlook for a decline in the TEL business remains.

Turning to slide 10, corporate costs for the quarter were $7.8 million compared with $6.5 million a year ago. The increase is primarily due to increased performance-related and share-based compensation accruals. Our effective tax rate for the quarter was 20.5% compared to 16.6% in 2011. On a year-to-date basis, our effective tax rate was 22.1% and we expect this may well come down slightly further during the course of the year.

Moving on to slide 11, cash flow from operations were strong again in the second quarter as we generated $12.3 million in operating cash flow more than double the $5.8 million recorded a year ago. Cash flow was partially offset by $1 million expense on implementation of the new ERP system and $1.6 million spent on the other capital projects. There have been no share repurchases to date in 2012.

As of June 30, we have cash and cash equivalents of $110.5 million which exceeded our total debt of $40 million by $70.5 million.

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

Thanks, Ian. Overall, we are pleased with our solid performance during the first half of the year, and as I am sure you understand, we are taking a very guarded approach to the remainder of the year as we deal with the uncertainties of the economies worldwide. At the same time, we are very confident that our business strategies are on track and that our business engines are solid as we pursue future opportunities.

We are very conscious of the difficulties facing our customers in all of our key markets as they deal with slow growth and inconsistent consumer demand. We continue to drive our strategy of developing highly cost-effective solutions to both improve customer products and reduce their cost.

We are also continuing our investment in R&D, targeting not only high-performance products, but also those with improved environmental impact. We are also very comfortable with our strong financial position which will enable us to respond to market opportunities, continue to prudently evaluate and pursue appropriate and complementary acquisition candidates and realistically consider programs that enhance shareholder value and returns, such as stock repurchase and dividend policies.

In the meantime, we are satisfied that investment interest in the Company remains high and that during the quarter we picked up another publishing analyst, a good sign that the market shares our confidence in the future of Innospec.

Now I'll turn the call over to the operator and Ian and I will take any of your questions.

(Operator Instructions). Jonathan Tanwanteng, from CJS.

Thanks for taking my question. Nice quarter, all things considered.

What are your thoughts about the rest of the year? Is it better or worse than when you exited the first quarter and do you have any expectations on pricing and foreign exchange over the next quarter or so?

Yes, I will let Ian talk about the part exchange, but I will talk about the quarter. I think as every CEO in the market today is looking at the uncertainties in the financial markets and geopolitics going on in certain countries, we would be irresponsible not to be doing the same. But in saying that, I think we are starting off strong. We are seeing a little glimmer of light that things might be improving and so our expectations are still, I would say, cautiously optimistic going into Q3 and Q4.

But again, being a responsible management team and being a fairly conservative management team, we will watch things. We'll watch trends very closely.

Yes, Jon, just to pick up on what Patrick said then in terms of FX, there's two things really that we need to say. First of all, our business was impacted by FX on the revenues line and if you look at our Fuel Specialties under our Active Chemicals businesses, both were negative 4% due to FX impacts. But our operating business is generally what we call naturally hedged. So down through operating income, we get the gains and losses and these tend to net themselves out to zero.

Where we saw the FX impact in our business is when we translate our non-US denominated balance sheet in Europe primarily in euro, sterling, and Swiss franc and that is where we get -- we had some movements in those currencies and that is where we have seen some losses. In previous quarters, we have seen gains in those areas. And as we look out into the future I can't predict where our currencies will go. But the important thing for us is where our operating business is naturally hedged and we can see some quality earnings going out of those businesses.

Got it. And pricing?

We are seeing some relief on raw materials. I think we'll see the positive effect in the latter part of Q3, early part of Q4. Understand the fact that obviously [credit] dropped down in the low 80s. Now it has popped back up to mid-90s on WTI. Brent is a little higher than that, about $12.00 typically on a premium basis. So we are starting to see some fluctuations on raw materials.

But I think it is a little give and get. I think we will be giving -- we will be getting a little better pricing but we will be having to give up a little bit to the customers. So, I think you'll see some improvement on pricing, but I wouldn't put a whole lot into it.

Got it. And then, you guys have done a good job on the recovery in gross margins in the Active Chemicals segment. Is there more upside there, given where Europe is and what people are saying about a hard [landing] in China?

I would probably leave it where it is. I think we have seen improvement. The issue within Active Chemicals is the Polymer businesses is in a state of flux due to the fact that most of that Polymer business sits within EMEA. And we all know what is going on within EMEA markets. If the EMEA markets would stabilize and start coming back up then we would see some glimmers of hope, I think you would see that Polymer business come back. But for right now where we sit, probably for Q2 and Q3 I wouldn't take Active Chemicals any higher than where it sits right now.

Got it. And one last thing. It sounds like you added Fragrances to the list of segments under pressure in Europe. Is that new or did I just miss that before?

No, it sits there. It is typically not under too much pressure. We just saw a little bit downside pressure in Q2 in the Fragrance market. Again, it doesn't have the pressure that Polymers has. But we saw some downward trends where we saw it pick back up in the Americas and a little bit in As-Pac. It suffered in EMEA. But I think that we'll see that again balance itself out as well.

Thank you. I'll jump back in the queue.

Christopher Butler, Sidoti & Company.

Good morning. I was hoping you can help me out. The language from the press release and your language from this conference call seems to be a little bit different. You are referencing cautiously optimistic, some investments, R&D. I note you are investing in sales facility but the press release was talking about cost containment, guarded preservation of cash, a lot more negative. Are you -- should I take the conference call as a better indication?

Yes. I think take the conference call as a better indication. Sometimes when you put press releases out, they are written in ways that probably don't express our true meanings. The comment around preservation of cash is more about not necessarily the concerns about the future markets. It is more about preserving cash for our capital management strategy which includes acquisitions, buybacks, and dividends.

You know, as we did in 2011 when one of the acquisitions that we were working on didn't go through, I think you guys saw within 72 hours we put a buyback in place.

We are in a similar situation. Something is going to happen. It is a function of timing. And we are not sitting on cash. We know sitting on cash doesn't do our investors any good, it doesn't help our Company end growth. There's just a proper timing for this and it is all a function of timing.

And looking at your specialties, the gross margin there, we typically see because of seasonality a step back in the second quarter sequentially. But you held up pretty well. Is that just a byproduct of oil coming in a little bit during the quarter or is there a step-up in product mix that took place as well?

A little bit of both. Little bit of both, Chris.

And then my odd question for the morning, the harvest in the US with corn, does that do anything for you as far as fuel mix as we look forward at all?

Yes, there was a little negative effect due to the fact of the drought conditions. So there was obviously a downslide on diesel consumption on that side of the market on the ag market. But I think that we have seen the negative effect of that.

I appreciate your time.

Thank you.

Ross Berner, Weintraub Capital.

So, can you just talk --? Two questions. One, just talk a little bit about -- you have talked about the acquisition opportunities in the past, both in oil service and also small deals that would be bolt-ons and including all the way up to something that is potentially transformative. Can you just give us a lay of the land in terms of things you are looking at and how you are thinking about the M&A opportunities in the market as it is now?

Sure. Not a problem, Ross. I think when we endeavored on the acquisition path, we have always stuck to our strategy of looking at smaller acquisitions below $100 million that had multiples that were in line with what we expect to pay. We looked at some transformational deals. The multiples are still extremely high in those, in those highly publicized markets. So therefore, we have kept to pretty much our strategy of smaller deals. And that is really what ties into the dividends and buybacks.

Transformational deals you put a lot of things on hold due to the fact you don't know where you're going to land. When we look at the acquisitions that we are targeting right now, we know that we could do those acquisitions and we could do buybacks and dividends at the same time.

And again, Ross, it is just back to a function of -- it is timing. We do have some things in play that are on the smaller side that will enable us to enhance both hopefully our Active Chemicals and the Oilfield service sector. And that is really where our target is right now until we see something in Fuel Specialties that is transformational or makes sense for us to go after.

But multiples in these markets are still extremely high, and we are not going to go out and pay something of a 9 or 10 multiple for a transformational deal. It just doesn't make sense for us.

And all the transactions you are looking at are you consider to be accretive even with the multiple that you have?

Absolutely.

And then I guess my last question is, you talked about conserving cash as being one of your primary strategies going forward. That idea seems a little bit in conflict or contradictory to both making acquisitions and implementing a buyback. So I -- maybe you just -- I'm not sure what you really meant to say. If you intend to buy back stock or make -- give these smaller acquisitions, that would not seem like conserving cash. Or are you saying you are conserving cash for those reasons?

That is correct. I think it is always in the text that sometimes gets misrepresented. Yes, the conservation of cash is strictly around acquisitions and buybacks and dividends. That is what we meant when we talked about conserving cash. I think the word was preservation of cash.

And do you feel like the first thing you do is exhaust the acquisition opportunity and then you -- I mean what you announce an acquisition and a buyback at the same time? I mean what --? If you feel like there is enough capital and cash flow that cash on the balance sheet and enough free cash flow going forward to do both, why not do the buyback first since you know that is going to be part of your plan regardless?

Well, again, we have got a couple of things going right now that we would like to see those play out and your original comment about would you or potentially could you announce both at the same time. That is not out of the question. It is just a timing issue.

Okay. Thanks, Patrick.

Gregg Hillman, First Wilshire Securities Management.

Hello. Patrick, could you review again who the end customers for the Polymer business in Europe, the industries that --?

Yes it goes into the automobile industry and the industrial markets. Predominantly the housing market.

And what is it used for or what is the functionality of the Polymer?

It is sort of a flexible plastic hosing, plastic PVC windows, those types of things.

Fairly commoditized market.

Okay. Is it a market you want to stay in?

You know, it is not a primary market for us. As you can see when we bought that asset that asset was primarily for Fuel Specialties for ethylene vinyl acetate to keep diesel from jelling. So during the wintertime you will see the primary go to Fuel Specialties and then a secondary, really, is to go to those other markets. So it is a must for us and it is kind of a secondary for that industrial and automobile markets.

Okay and on your new oil service chemical business do you serve off shore oil rigs with any chemicals or products?

Not at this time, but some of the acquisitions that we are in line we will be doing some offshore servicing.

I take it they use a lot of chemicals.

That is correct.

Okay. And then, just in the United States with the catalytic converters and [Navastar], I think, going toward urea. Do you make anything that goes into catalytic converters for diesel trucks?

No, no, we don't. Not for necessarily the converter and we are not in the urea business obviously. But no.

Is there -- I guess, just in new products in general is there anything you can say that has already been publicly stated or in a trade journal or anything like that?

No. What I can say is we are continuously putting out new products and I think you guys have typically seen the percentage out there is 35% to 40% of new products over five years constitute our sales. And I think that we are on that track. I mean, we are pushing the envelope on technology. Not only because of the fact that the environmental impacts, the engine impacts, the regulatory impacts, but I think also to keep ahead of the game and to make sure our customers are getting the best products for the marketplace. And that is our focus.

So we are always putting out new products. I think we are always pushing the envelope on R&D and we will continue to do that.

Thanks very much.

(Operator Instructions). Chris Shaw, Monness, Crespi, Hardt.

Good morning. Can I ask about Fuel Specialties for a second? You -- in the release I think you said North American sales were down 3%, Europe and Asia were flat. I was curious because I think I thought Europe would be worse off. What is going on in North America right now that is causing the [weak compliance]?

I think a couple of things. I think there was timing of shipments in Q2. Quite frankly I think there was some destocking in Q2 due to the fact that people were -- are expecting price relief. Customers are expecting price relief on a raw material basis. So that is why we saw a little bit of weakness in the US market in Q2, and I think you'll see back to regular demand in Q3.

Is that bearing out already through July? I would think with oil moving up there would -- the anticipation of lower prices would be over at this point?

It is. It is.

Okay, thanks. And then I noticed in the Octane Additives business year over year -- this might have been happening for previous quarters, but there was a pretty big drop in admin cost. Is that the legal expense from lawsuits and such?

Yes. That's right. We have a $3 million pretax charge in this quarter last year and that is nonrecurring this time around. So you are spot on.

That's really it. You have answered a lot of the other questions before. Avtel, where is -- geographically is that more Europe versus more US or is it sort of split evenly?

It's more US.

All right. Great. Thanks a lot.

Jonathan Tanwanteng, CJS Securities.

In the Octane segment, you've got a nice extension in being able to create low-margin inventory there. I know that you said the business would not be as good as the first half, but is the margin opportunity still there? And then, juts I guess longer term, I know you said -- I know you guys are expecting this business to be terminal eventually, but any change given where the FAA has talked about Avtel?

Yes, it's two things. I think there are opportunities to keep pushing lower-cost inventory through for the remainder of this year. But into next year, it really depends on demand and order patterns. Obviously the higher demand the more volume we can push through the plans and the lower the unit cost. So we'll have to wait and see next year.

I think as we move through it in 2013 or possibly into 2014, our expectations are that the gross margins in our business will deteriorate from where they are today and in terms of the FAA announcement not related to our Avtel business and that sits out in Fuel Specialties and they are staying pretty much in line with where our thinking is round about 2018 for that market. And we don't see any real change from that right now.

Got it. Thanks.

Chris Shaw, Monness, Crespi, Hardt.

Sorry, I forgot one. I just wanted to know, you guys -- how much of your cash is in Europe versus the US? Is that an issue in terms of looking at deals and trying to conserve cash right now?

Yes, we have most of our cash swept into our Central Treasury function which is based out in the UK. But we can move cash around the globe and when the deal is there and in place we will have the cash in place to do that.

And you can do that efficiently on a tax basis?

Yes, we can. Yes.

Okay. Great. Thanks.

Ross Berner, Weintraub Capital.

Patrick, can you just talk a little bit about volume trends so far this quarter?

Yes. I could tell you it has been a -- basically a volume and price mix that has really helped out Europe. I think Asia-Pacific we have seen volume about where we expected. Fairly square, fairly even. US, we saw volume demand drop a little bit and again I think a lot of that was a little bit of destocking going on with the expectation of raw materials cost coming down.

But I think if you look at fuels overall, diesel is up a little bit on consumption; it is flat in Europe; it is up about 3% in Asia-Pacific and it is up a couple of percent in the Americas. If you look at gasoline it is down across the board in all three regions. And if you look at Active Chemicals, I think on a volume basis, Personal Care is way up on a volume basis. And then of course as we expected on a Polymer basis, volume is down.

And one last observation is stock is down almost 10% on virtually no volume. I know you would be precluded from being in the market today, but this is kind of -- I really don't understand why the stock is down so much, but this is the kind of day you would want to have a buyback in place.

Understand and note taken.

Thanks, Patrick.

Thanks, Ross.

Ivan Marcuse, KeyBanc Capital Markets.

Thanks for taking my questions. You may have answered this but I just have a couple of quick ones. On a sequential basis from first quarter to second quarter did you see the vol -- what did volumes do exclusive of pricing when you look in the Fuel Specialties? Were they down pretty evenly from quarter to quarter across the regions or was there another region that was maybe declined more than another?

Yes. We saw volumes in EMEA fairly flat. We saw volumes up a tad in Asia-Pacific and as we discussed just right before you came on, the volumes in Americas were off a little bit. And we think some of that had to do with some destocking going on in Q2.

Got you. So if you go into Q3, I guess you would expect a sequential increase. In other words, with materials falling off would you expect a gross margin expansion?

Minor. Very minor.

Thank you for taking my questions.

As there are no further questions, I would like to hand the call back over to Patrick Williams for any additional or closing remarks.

Thank you all for joining us today and thanks to all our shareholders, customers, and Innospec employees for your interest and support. If you have any further questions about Innospec or matters discussed on this call, please give us a call. In the meantime we look forward to meeting up with you again next quarter. Thanks again. Have a great day.

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