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Innospec Inc. (NASDAQ:IOSP)

Q2 2013 Earnings Call

August 8, 2013 10:00 AM ET

Executives

David Williams - VP, General Counsel and CCO

Patrick Williams - President and CEO

Ian Cleminson - EVP and CFO

Analysts

John Tanwanteng - CJS Securities

Andrew Dunn - KeyBanc

Christopher Butler - Sidoti & Co.

Gregg Hillman - First Wilshire

Operator

Good day ladies and gentlemen, and welcome to the Innospec Q2 2013 Earnings Call. For your information, today’s conference is being recorded. At this time, I would like to turn the conference over Mr. David Williams, General Counsel. Please go ahead, sir.

David Williams

Thank you and good day everyone. My name is David Williams and I am Vice President, General Counsel and Chief Compliance Officer at Innospec Inc. Thanks for joining our second quarter 2013 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, 2013. The press release is posted on the company’s website at www.innospecinc.com. An audio webcast of the call and a slide presentation on the results are also now available and will be archived on the website.

Before we start, I would like to remind 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.

With that, I will turn it over to you, Patrick.

Patrick Williams

Thank you, David, and welcome everyone to Innospec’s second quarter 2013 conference call. We are pleased to report that Innospec performed very well during the second quarter maintaining first quarter momentum despite continuing challenging economic conditions and strong competition in key markets worldwide. We have delivered on our expectations and grown our businesses while maintaining margins at our core business areas. Our close attention to working capital management coupled with our strong cash generation capacity has resulted in a very strong balance sheet providing us with good financial capability.

This allows us to remain well positioned to take advantage of growth opportunities and invest strategically in new technologies. We continued to build out our compliance programs and evaluate our policy on share buybacks and dividends. Our fuel specialties business once again delivered and excellent quarter and we are very pleased with our consistent performance in this group. We have developed momentum in our oilfield specialties business and the integration of our recent Strata controls acquisition is going well.

Strata provides state-of-art solutions to the oil and gas drilling industry for mud and fluid losses and is a higher margin contributor to this business. Fuel specialties Avtel business, as we anticipated in the call last quarter did normalize in Q2. Overall fuel specialty sales and margins improved particularly in the Americas, where sales increased 10%. At the same time our EMEA market shows 13% sales growth particularly important considering the continued sluggish fuel demand in the region.

Our business in the Asia Pacific regions showed similar good top and bottom line performance during the quarter with a 27% increase in sales. Performance Chemical results as expected were essentially unchanged year-over-year. Sales growth softer than in first quarter 2013, but our key personal care business showed good progress with good underlying growth momentum particularly in the Americas. This had essentially been driven by our expanding new product pipeline.

Fragrance ingredients also had a good quarter where we remained watchful of market conditions. Meanwhile our polymers and industrial business continues to be negatively impacted by the sluggish European economies, softened demand and excess supply. Our management group continues to monitor this market very closely and discuss various production conditions and other asset alternatives.

Octane additives, as we have indicated regularly is an industry that is an ever rewinding down as the remaining countries work towards to phase out of leaded gasoline. Our revenues for the second quarter were down 25% from prior year. However, visibility for the second half of the year hasn’t proved somewhat with the expected conformation of one contract. Beyond that, into 2014 the situation remains unclear.

All-in-all we had a fairly strong comparable quarter both year-over-year and on a sequential basis. Our core operations moves forward in line with our plans. Strong working capital management reduced our working capital by $6 million from Q1 and good positive cash inflows of $19.7 million enabling $4 million reduction in our debt. This provides flexibility for future growth and expansion opportunities. We remain in excellent financial health.

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

Ian Cleminson

Thanks Patrick. Turning to slide six in the presentation, the company’s total revenues for second quarter were 185 million, a 4% increase from $178.5 million a year ago. The overall gross margin increased slightly from last year to 32.1%, driven by continued strong growth in fuel specialties and solid performance in the personal care and fragrance ingredients within our Performance Chemicals segments.

Our GAAP earnings were $0.71 per share, up from the $0.65 per share reported in last year second quarter. On an adjusted basis our earnings per diluted share were $0.75 which exceeded consensus analyst expectations for the quarter. EBITDA was 25.8 million, and net income was 17.1 million up 1.6 million from the second quarter of 2012.

Moving on to slide seven revenues in fuel specialties for the second quarter were 126.2 million, 10% higher than the 114.5 million reported in last year's second quarter. The increase was primarily driven by 6% higher volumes on a 3% sub list from the inclusion of the strata business, with the richer sales mix adding a further 1%.

By region revenues increased 7% in the Americas, 13% in EMEA and 27% in Asia Pacific. As previously predicted our total sales in the second quarter normalized. Margins in these segments increased by 1.8 percentage point from last year to 32.1%, gross profit was 40.5 million and operating income was 19.2 million up from last year's 16.9 million.

Turning to slide eight, performance chemicals revenues in the second quarter were essentially unchanged at 44.5 million. Volumes increased by 3%, primarily driven by personal care, and fragrance ingredients, as these sectors delivered strong sales momentum across all regions which was offset by 3% lower pricing and a weaker sales mix.

Currency effects reduced reported sales by 1%, by region revenues increased by 3% in the Americas. Asia Pacific sales were on a par with last year and revenues decreased 6% in EMEA, primarily due to lower industrial demand. Gross margins fell slightly to 25.4% a result of lower selling prices and a weaker polymers sales mix. Performance chemicals operating income for the quarter was 6.5 million compared to the 7.2 million reported in last year's second quarter.

Moving on slide nine, net sales and (inaudible) for the quarter were 14.3 million compared to the strong comparative quarter of 19.1 million a year ago. This represents a 25% decline and is in line with expectations.

Segments gross margin improved to 53.1% up from last year's 51.8%, gross profit was 7.6 million in the quarter. Segments operating income for the quarter was 6.1 million compared to 8 million last year.

Based on the limited visibility we have we now expect second half revenues will be similar to the first half year revenues subject to customer order patterns, at this point we have no visibility for 2014.

Turning to slide 10 corporate costs for the quarter were 8.5 million, compared with 7.8 million a year ago, the increase was due to higher legal, enhanced complaints and acquisition related costs partially offset by lower share based compensation accruals. As expected the quarterly pension charge was $0.7 million compared to a $0.1 million pension credit a year ago. Our effective tax rate for the quarter was 18.2% compared to 20.5% in 2012 second quarter and for the full year we expect it to be approximately 20%.

Moving on to slide 11, cash flows from operations remained strong in the second quarter as we generated 19.7 million in operating cash flow, a 60% increase from the 12.3 million recorded a year ago, reflecting good control of working capital. As of June 30th we had cash and cash equivalents of 59 million and debt of 33 million providing us with a healthy net cash position of 26 million. And now I'll turn it back over to Patrick for some concluding comments.

Patrick Williams

Thanks Ian. In summary we are pleased with our performance in the first half of 2013 and continue to view the second half of the year with cautious optimism. We are well positioned both financially and operationally for continued growth for the remainder of the year, although we continue to closely monitor markets around the world.

I continue to be very proud to lead a dynamic organization which focuses on its customers and stakeholder needs in a safe and efficient manner; our success in bringing innovative technology to the market, combined with our spanning global footprint makes me confident that our strategy is robust.

Field specialties continues to perform exceptionally well and we have every confidence in our business prospects and capabilities here. Having said that we should once again note, this is a highly competitive market particularly with respect to tender offers. We have a good track record in tenders and we continue to feel confident in our prospects especially with our quality of products and high level of customer service. We are satisfied with continued evolution and accretive contribution of our strata controlled business and we are still actively pursuing acquisitions in both the oil field specialties and personal care sectors.

We remain confident in the resilience and continued growth prospects of our personal care business and are taking a close look at business strategies and alternatives in the weaker polymers and industrial business sectors of our performance chemicals group.

Finally and mindful of our continuing financial strength and balance sheet position, our board continues to evaluate its alternatives in returning vale to our investors including share repurchases and dividends. We also continue to invest in our business in R&D for new products and technologies that deliver to our customers' needs and in maintaining world class compliance systems.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions), we will now take our first question from John Tanwanteng of CJS Securities, please go ahead.

John Tanwanteng - CJS Securities

Great gross margins especially in a difficult macro environment; I'm just wondering how sustainable they are by segment and particularly for fuel specialties if you are planning to break at oil field in to its own segment later.

Patrick Williams

We have no information right now that suggests any change in margins up or down. I think we're obviously looking at raw materials continuing to evaluate our position [Audio Gap] margins are sustainable throughout the rest of the year.

John Tanwanteng - CJS Securities

And then could you talk a little bit more about the timing and the scope of the two potential acquisitions that you mentioned? And if you are planning to finance any free cash or debt?

Patrick Williams

We'll talk about those, if you recall the last couple of quarters we've been looking at acquisitions, one particularly in oil field and just as of recently one in the personal care sector as well. Our view is that both will close and I hope will close in Q3, as you are all very well aware we're very stringent on our acquisitions and we're not afraid to walk away from the deal that's not fit for purpose for our organization.

But I do think that the two that we have in the queue right now has a very good probability of closing sometime during the next 60 days.

John Tanwanteng - CJS Securities

And then just for Ian, you had 1 million other expense, I am just wondering what that was?

Patrick Williams

1 million in?

John Tanwanteng - CJS Securities

Other expenses in the quarter?

Unidentified Company Representative

Other expenses, that will be foreign exchange.

John Tanwanteng - CJS Securities

And then one final one for Patrick, maybe do you see any potential impact to your field specialist from a potential relaxation of ethanol mandate in the U.S.?

Patrick Williams

We monitor that quite a bit John and I think that we're still in that stage. You got to remember we treat a lot of that ethanol as well, corrosion inhibitors. So we’re pretty confident right now that whether it goes with, it goes or not we're still well positioned to market place.

Operator

We will now move to our next question from Andrew Dunn of KeyBanc Capital Markets.

Andrew Dunn - KeyBanc

Looks like your growth rates across regional markets and field specialties were really solid. I was wondering if you could just give a little more color on doesn't seem like you are growing faster than the overall markets, maybe if you are taking some share. And also particularly looking at Asia-Pac the 27% up that you reported is a pretty big swing from I think the down 1% last quarter. So maybe you could comment a little bit more on that as well.

Patrick Williams

Some of its timing of orders Andrew, some of its product mix and some of it is you are correct a taking of market share. Albeit there is some slow demand in some of the countries in Europe, we're still seeing pretty steady demand in the Americas and fairly steady demand in Asia Pacific. Asia Pacific is always a tricky one, we monitor it very closely. I do think a lot of that was particularly probably order pattern more than anything else. But I think that we're properly positioned in strong positions in all three regions. And I think we have definitely taken market share in all three regions.

Andrew Dunn - KeyBanc

Great and just one follow up, with the time you just laid out for your potential acquisitions flows didn't get done in 3Q or 4Q, we expect to see a lot more certainty around actions on a share repurchase of dividend given the discussions you have laid out.

Patrick Williams

Yeah I do. And quite frankly with the financial situation we're in, there is no reason why we can't do both acquisitions and potentially buybacks or dividends in the future sometime this year as well. We are very transparent with our investors as you guys know; we continuously talk about dividends and buybacks, what we want to do as a management team and I think that we're well positioned to potentially do some form of dividend and both acquisitions. It’s a function of timing right now.

Operator

Our next question comes from Christopher Butler of Sidoti & Company. Please go ahead.

Christopher Butler - Sidoti & Co.

Just coming back to the margins on fuel specialty, could you give us a little bit more detail on what you are seeing on the raw material side of the environment and it looks like you got some prices increases here in the quarter. Is pricing environment in decent shape in that regards as well?

Patrick Williams

If you look at raw materials Chris there has been a little rise due to the fact you have watched crude oil come to equilibrium. So crude was sitting at an average of $90 a barrel, give or take a little bit of that in Q1. Now we’re upwards of over $100 of barrels in Q2. But there hasn't been a major swing risk; we're not seeing the drastic swings we had in the past, where you saw WTI or Brent swing in 20% to 30% and obviously swinging raw materials the same.

So it's been fairly steady, we might see a slight increase in raw materials gone in the Q3, but I don't think it's negatively going to affect our margins longer term.

Christopher Butler

And shifting gear to corporate costs, last quarter you indicated that you are going to see a couple million dollars of increased legal fees this time around. You did mention that you saw some but did you see the full magnitude of that here in this quarter? And if you did where did you see savings that kept corporate costs in and around historical averages.

Patrick Williams

Yeah Chris if you recall on the last call we did on Q1, we did say that we'd continue to see higher legal and compliance fees in Q2, Q3 and Q4. And certainly indicating Q2 we incurred about an extra, just over $2 million of legal and compliance costs, where we saw some of that offset was again some of our share based compensation and some of our longer term incentive plans, so there was a credit there against some of the legal cost.

Christopher Butler - Sidoti & Co.

And looking at the polymers business, do I get a sense that there is the change in run rate that this may not be a business that you want to hold long term and might be part of a portfolio shift?

Patrick Williams

No, not on the polymer side, what we’re really doing there is looking at just alternative markets for some of our polymers if fuels can’t take the majority of that polymer. So no, it’s still very strategic to us, it’s not a situation where we’re looking to divest the asset, that’s probably all I’d say there Chris.

Christopher Butler - Sidoti & Co.

And just touching on the octane additives, you said that you had one contract lined up for the back half of the year. Is that one out of how many is it one per country that you have ongoing at this point? And, are you less certain looking out to 2014 and you were, it sounds as if you’re extra cautious, am I reading that right?

Patrick Williams

No, I mean, I would say there is, realistically there is probably two countries left in mo gas. We’ve got a contract for one country which gives us a little more clarity going into, the rest of 2013 and the majority of 2014, which is on the positive side. The other contract is still an unknown and that’s why we still keep our cautious comments around mo gas.

Operator

(Operator Instructions) We will now take our next question from Gregg Hillman of First Wilshire Securities Management. Please go ahead.

Gregg Hillman - First Wilshire

Pat, can you talk about how your oil field chemicals are differentiated from other sort of competitors, like multi camps for example.

Patrick Williams

Sure. I think it’s a fairly small business right now as we’ve discussed and it really is if you go back in history of the company, Gregg, it’s very similar to have how I built this business when we started it in the early 90s. We differentiate ourselves via technology as much as possible but more importantly and just as important, we do it through customer service and being onsite, on-demand 24x7. So I think what you’ve seen is that we’re able to compete against the majors due to fact that we are small enough to do these things and don’t get caught in the corporate grid lock.

I think as well as that we’re really focusing on technology. I think you got to make a difference in this market, via technology. And if we can treat certain crude and certain problems that well had with either new technologies or modification of technologies, that’s where we stand out. The biggest issue from a growth standpoint in that market is that we’ve really got just to get more breath. We’ve got to get a little more, one more acquisition to push us to that next level and obviously that’s what we’re working on today.

But I am very satisfied with where we are and where our margins are today, but I want to get there obviously a lot faster and doing some of these acquisitions and putting the proper strategy in place should enable us to do that.

Gregg Hillman - First Wilshire

Okay, and just kind of following up on, do you have any products in oil field that are more environmentally friendly maybe that are, I don’t know, breakdown more easily than like (inaudible) or something else that’s currently being put down the hole?

Patrick Williams

I think if you look at the industry as a whole, everybody is looking to things that are more environmentally friendly and that’s a focus of our R&D when you start pinpointing oil field specialties. Right now if you run a lot of the test metrics that have any water interactions down hole there is a little bit of a misconception in the marketplace that these are bad for the environment. So you got to be very careful in what is perceived in the marketplace as to what is reality. But yes we are continuously looking at, Gregg, what will be the most environmentally friendly product set that don’t necessarily lose a lot of the performance characteristics that you have today, whether you’re going vertical or horizontal. And we’re looking at today either buying into or develop it ourselves, and that’s going to be a continuous process.

Operator

We will now take a follow up question from Andrew Dunn of KeyBanc Capital Markets. Please go ahead.

Andrew Dunn - KeyBanc

Just one more follow up on your oil field business. Can you tell us if you picked up any additional customers or trial projects in the quarter? And just one more part to that is, is your focus on acquisitions in that area, would you say that maybe as you wait to fold in another potential part of that business you may have held off a little bit on looking for new customers or is that not really how it’s playing our right now?

Patrick Williams

No, that’s not us playing out. I mean, we’re continuously focusing on new customers. You’ve got to remember there is a balance, Andrew, the LCM business that we bought, which is more upstream at the wellhead per lot circulation and in the production side, which is after you’ve completed the well. So, we’re continuously focused on the production side, going out for new customers. And on the LCM side as well not only fixing and more professionalizing that business for longer term growth but really looking at global enhancement of that product line. So it’s really a combination of both.

Andrew Dunn - KeyBanc

And were you able to pick any up that you can tell us about in the quarter or nothing that you can mention?

Patrick Williams

Yes, we don’t give specifics about customers but yes we have definitely been able to pick customers up.

Operator

As there are no further questions, at this time, I’d like to hand back to Williams for any additional or closing remarks.

Patrick Williams

Thank you all for joining us today, and thanks to all our shareholders and Innospec employees for your interest and support. If you have any further questions about Innospec, or matters discussed in this call, please give us a call at any time. We look forward to a meeting with you again next time in next quarter. Thanks, and have a good day.

Operator

That will conclude today’s conference call. Ladies and gentlemen, thank you for your participation. You may now disconnect.

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