Good day, and welcome to the Innospec Q1 2014 Earning Results Conference Call. Today’s conference is being recorded. At this time, I would now like to turn the conference over Mr. David Williams, Vice President of General Counsel. Please go ahead, sir. .

Thank you, and good day, everyone. My name is David Williams, and I’m Vice President, General Counsel and Chief Compliance Officer of Innospec. Thanks for joining our First Quarter 2014 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, 2014. The press release is posted on the company’s website, 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 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..

And with that, I will turn it over to you, Patrick. .

Thank you, David, and welcome, all of you, to Innospec's First Quarter 2014 Conference Call. .

We are pleased to report that year-end momentum in our core businesses continued through the first quarter. We saw excellent contributions from the strategic acquisitions we made in 2013.

However, and very importantly, we also saw growth in the underlying performance of our existing businesses, particularly Fuel Specialties and the Personal Care sector of our Performance Chemicals business. .

As expected, our Q1 results included virtually 0 sales from our Octane Additives business, and so the reported bottom line doesn't compare favorably with prior year. However, we have delivered good financial results from our growth businesses, results that are expected to improve further as we move into 2014.

We expect Octane Additives to recover in Q2 and the remainder of the year. But our long-term prognosis for this business remains unchanged. .

Fuel Specialties and Performance Chemicals are growing as expected, filling the financial gap left by the Octane Additives business. We're achieving this through focusing on customer service and delivering a strong pipeline of new technologies and new products.

We've had good contributions from our recent acquisitions even during the integration phase, which makes us very positive about their future contributions. .

Overall, this performance is a testament to the resiliency of our business model, and we fully expect to see continued improvement. While global markets in general were fairly soft, our Fuel Specialties business delivered a particularly strong performance. Sales were up 17%, driven by volume growth in both our Fuel and Oilfield Specialties business. .

Fuel Specialties revenues continue to grow in Americas according to plan. The cold winter was somewhat beneficial, but the business as a whole was very strong. The markets in Europe, the Middle East and Africa increased over last year on improved volumes. And Asia-Pacific has started to pick back up from a contract loss in 2013. .

In Oilfield Specialties, we are particularly, pleased with the sales growth contribution from Bachman, our most recent acquisition in this business. Bachman has some exciting technology developments underway, and we're looking forward to continued strong performance from this business.

The integration of Bachman into Innospec's global network is moving ahead as planned. .

Overall, gross profit was up more than 10% in Fuel Specialties, principally driven by acquisition growth, while operating income improved some 4%. .

Importantly, we maintained a healthy margin of 31.7% in this business, despite a weaker sales mix in Asia-Pacific and a softer trading of AvTel. We expect both of these to improve as we move further into the year. .

Our Performance Chemicals business showed an excellent 17% top line improvement year-over-year. This was driven mainly by continued growth of our Personal Care business including particularly strong performance from Chemsil and Chemtec, our 2 acquisitions we concluded late last year.

Both companies have been successful integrated and have contributed significantly to the enhancement of our product offerings to the Personal Care customers. They have also provided us with an extension of our R&D pipeline, which will enable us to deliver a wider range of applications for our products. .

Our strong Personal Care business performance more than compensated for the weakness in the Polymers business, as a consequence of our incident at our facility, which resulted in some supply interruption. Fortunately, no injuries were sustained as a result of this incident and the facility is once again running.

In the quarter, Performance Chemicals gross margins showed continued improvement on a favorable sales mix. .

As previously mentioned, we had virtually 0 sales from our Octane Additives business in first quarter. We do anticipate Q2 and the rest of the year to pick up, as we fulfill on the one remaining contract we have in Motor Gasoline. This business will continue to wind down with very limited visibility beyond the short term. .

I will now turn the call over to Ian Cleminson, who will review our results in detail, and then I'll return with some further comments and discuss outlook and strategies moving forward. Then we will take your questions. .

Thanks, Patrick. Turning to Slide 6 in the presentation. The company's total revenues for the first quarter were $220.7 million, an 11% increase from $199.4 million a year ago.

The overall gross margin was 29.8% as continued growth in Fuel Specialties, improved revenues in Performance Chemicals and solid contributions from our recent acquisitions, offset the expected very low quarter in Octane Additives. .

Our GAAP earnings were $0.69 per share, compared to the $0.75 per share reported in last year's first quarter. Our adjusted earnings were $0.54 per share, compared to the $0.72 per share reported a year ago, which benefited by approximately $0.18 per share from the Octane Additives business.

EBITDA for the quarter was $27.1 million, down only 3% from last year. Net income for the quarter was $16.9 million. .

Moving on to Slide 7. Revenues in Fuel Specialties for the first quarter were $164.2 million, 17% higher than the $140 million reported a year ago. The increase was primarily driven by volume growth in our Fuels business augmented by a strong contribution from the Bachman acquisition, which added 13% to revenues.

Excluding the acquisition, there has been a 4% improvement in volumes and a 1% favorable currency impact, offset by a 1% weaker sales mix. .

By region, revenue in the Americas grew by 43%, driven by acquisition growth and improved volumes; and in EMEA, by 10% driven by increased volumes and a richer sales mix. Sales in Asia-Pacific declined by 17% in the quarter, primarily as a result of weaker sales mix and a very strong comparative quarter. .

The segment's gross margin was 31.7%, down from 33.6% recorded a year ago, a reflection of lower AvTel sales from a strong comparative period. Gross profits was $53 million, and operating income for the quarter was $25.8 million, a 4% increase from last year's $24.9 million. .

Turning to Slide 8. Revenues in Performance Chemicals for the first quarter increased 17% to $56.1 million, driven by strong underlying growth in the core Personal Care business and augmented by acquisition growth from Chemsil and Chemtec, which contributed 16% to revenues.

Excluding the acquisitions, underlying sales across Performance Chemicals grew by 1%, benefiting from a 2% favorable currency impact offsetting 1% lower volumes. .

By region, sales increased 21% in the Americas driven by the acquisitions; 11% in EMEA; and 24% in Asia-Pacific due to continued growth in the Personal Care markets and a richer sales mix. Gross margins improved to 24.2%, as Personal Care expanded its segment share.

Performance Chemicals operating income for the quarter was $6.5 million, 13% higher than the $5 million reported a year ago. .

Moving on to Slide 9. As we predicted Octane Additives has experienced a very slow start to 2014. Net sales for the quarter were $0.4 million, compared to $11.6 million a year ago. This segment reported an operating loss of $1.2 million during the quarter, compared to an operating income of $4.8 million in last year's first quarter.

We anticipate a strong recovery in this business in the second quarter, and still expect the full-year operating income to be broadly half of the level achieved in 2013. .

Turning to Slide 10. Corporate costs for the quarter were $12.1 million, compared with $11.5 million a year ago. The increase was partly due to amortization related to the implementation of the newly -- of the new company-wide information management system.

We expect our corporate cost to be slightly lower in Q2 and beyond, as our compliance efforts are now largely completed. .

The effective tax rate for the quarter was 11.1%, reflecting the positive impact of the adjustments of income tax provisions in the quarter. Broadly, we expect the full year effective tax rate for 2014 to be 23%. .

Moving on to Slide 11. We closed the quarter in a net debt position of $43.8 million, significantly reduced from $61.2 million at the end of 2013, showing that our business model continues to be highly cash generative post-acquisitions. Net cash generated from operations was $20.9 million, a 17% increase from the $17.9 million reported a year ago.

As of March 31, we have cash and cash equivalents of $95.9 million and debt at $139.7 million. .

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

Thanks, Ian. In summary, we are pleased with performance of our core businesses and the acquisitions we made last year. Our key businesses have delivered as we expected, despite the challenges of uncertain growth markets worldwide. Critically, we have offset to a good degree the diminishing contribution of our Octane Additives business.

We have built a solid foundation for sustainable growth at Innospec, upon which we anticipate both further organic and acquisitive growth. .

Meanwhile, in terms of EBITDA and cash generation, we are confidently positioned for the future, with a strong balance sheet and our continued robust financial performance.

Importantly for our shareholders, we have continued our balanced capital management program and decided to expand our biannual dividend policy with an 8% increase in our payout for the first half of 2014 to $0.27 per share. .

We will continue to review our dividend policy, as well as other forms of capital management, in conjunction with the strategic needs in our financial performance of the business. For the near term, we will continue to focus on sales growth and the successful integration of the acquisitions we made in 2013. .

Nevertheless, we will continue to be aware of attractive investment opportunities, particularly in Oilfield Specialties and Personal Care. And we will continue our strategic priority to maintain our reputation as the most innovative solutions provider with the best products and best technology for our customers' applications.

I would like to take this opportunity to thank our customers and our shareholders for their continued support. .

Now I will turn the call over to the operator, and Ian and I will answer any of your questions. .

[Operator Instructions] Our first question today comes from Jon Tanwanteng of CJS Securities. .

You've obviously done a very good job of rotating out the Octane business into attractive growth businesses.

I'm just wondering what the priority is for cash going forward? Is it still further M&A? Or do you expect to pay down some debt first?.

We've made the 4 acquisitions Jon, the last 14 months and we're still less than 1x levered. It's a positive from the standpoint, that we obviously know how to balance and work our balance sheet in appropriate ways. So there's really not a lot of debt we need to pay down. I think the most important factor here is that we've increased the dividend.

We will look at that moving forward, potentially balanced out with buybacks and/or increase in dividend or both, as well as focusing on our assets and organic growth of those assets to make sure that we have the proper cash available to grow these businesses appropriately of what we acquired. .

I think, additionally to that, we will still look at acquisitions, new Oilfield sector and the Personal Care sector. And obviously, if something in the Fuel Specialties line came around that would really stabilize the market end or help us from a technology standpoint, we would look at that as well.

But right now, our focus, really, has been dividends, looking at potential buybacks down the road, internal growth, integration, and not shutting the pipeline down on acquisitions. .

Okay, great. And then SG&A and R&D were at worst [ph] a bit higher than we had expected. Ian, you said the compliance initiatives are now finished.

I'm just wondering how we should think about the run rate for operating expenses going forward?.

Yes, you're absolutely right, Jon. We've now completed the buildout of our compliance program, and we expect our corporate cost to be broadly $1 million to $2 million lower per quarter going forward. The rest of our SG&A costs have spiked this quarter year-over-year by about $6 million, but all of that is due to the acquisitions.

Our actual core costs are actually down a little bit, in both Performance and Fuel Specialties. So going forward probably $1 million to $2 million per quarter, lower in total. .

Okay.

And then finally, can you talk about the exposure you might have in Eastern Europe and Russia? Do you expect any impact from the situation in the Ukraine at all?.

Yes, I mean, as you can imagine, it's a fluid situation right now. And obviously, we're going to follow all the EU sanctions, as well as the U.S. sanctions, within that region. As of now, we have not been negatively affected, Jon. But again, moving forward, it's constantly changing, and we're just going to have to manage this appropriately. .

Our next question today comes from Christopher Butler of Sidoti. .

Going back to compliance costs for just a second. The first quarter of last year you had about $2.5 million more of compliance cost versus the year before in the first quarter.

Were they the same in the first quarter this year and then going down? Or did you see any help from that? And then, sort of the add-on is do you at some point near now, you should be removing the independent monitor from your compliance cost as well, right ?.

That's correct, Chris. We're not yet in a position, where we can announce the monitor has finished, but we are right near the end of that process. Our expectation is that our compliance cost will start increasing in Q2 and beyond.

And I said earlier on the call, we expect that total to be round about $1 million to $2 million a quarter as we move forward. .

And do you expect there to be offsetting increase with the information technology cost going forward?.

We do, but we will have a slightly higher amortization challenge, which we are currently running through our corporate cost line. And that's already built in for the Q1 numbers, and that'll stay with us for a number of years, but it's a net gain for us overall. .

And could you speak to the contract in Asia that you lost in? Is that tied in with the AvTel decline that you saw there?.

No, it's not tied into the AvTel. AvTel sometime can -- sometimes can be a little lumpy as you know. We expect the AvTel to pick back up in Q2. As a matter of fact, we know it's going pick back up in Q2. We don't talk about customers on the conference calls in regards to who we lost. But this was a contract that we discussed in 2013 that we've lost.

But quite frankly, we've won more contracts than we've lost, and that's probably the most important. And I do think and we feel very confident that you'll see As-Pac pick up in Q2 by recent closures that we've made. And quite frankly, by the first month that we've had in Q2, we're seeing positive trends all across the board in all of our businesses. .

Now knowing that AvTel is a better margin for you, could you quantify the 17% revenue decline in Asia? By how much of that was just AvTel and weak mix?.

Most of it was the contract loss that we spoke about a little bit earlier, Chris. None of it was AvTel and there's a little bit of sales mix in there as well. .

Our next question today comes from Gregg Hillman of First Wilshire Securities Management. .

Yes, Patrick, could you talk about -- I guess, basically, the emerging environmental problems from frac-ing and whether you think that will affect you in other ways? And also, how does the new products from Bachman mitigate environmental impact from frac-ing?.

Sure, Gregg. I could obviously answer this question in hours, but I'll try to cut it short as I can. Frac-ing has really changed the global markets in the oilfield sector, whether it's oil or gas. And with frac-ing comes a lot of environmentalists, as we all know, preaching that there's interaction with water tables.

There's also earthquakes that have been happening in certain areas. We're somewhat naturally hedged, Gregg, because we don't deal with frac fluids. We're either on the, a, the drilling side; or b, we're in the production side. So we're really not into the frac fluids per se. .

Now obviously, if there was a global ban on frac-ing, that would slow rig count down, which would slow everybody down. We don't see that happening. Now there will be obviously some rules, laws, regulations that will be state by state in regards to what dossiers you put in place, et cetera.

But we're fairly confident that we're naturally hedged on the drilling side and production side, and not necessarily heavily exposed on the frac stem side. .

In regards to the global markets and where we stand, I think we're in a positive position for all of our businesses. We have really focused on a lot of the growth markets in Asia-Pacific, Middle East and Africa with our new acquisitions. And I think that we're properly positioned moving forward. .

And then, just -- and could you comment on your new products, I guess, at Bachman, but also Chemsil and Chemtec, too?.

Sure. Quickly with Bachman, I mean, a lot of this industry is changing just due to the evolution of the industry. And we're constantly promoting new molecules and new products in all of our business lines.

So when it comes to some of the products that we feel very confident -- our H2S apparatus that we have in Bachman; our corrosion inhibitors for asset integrity, whether it's for pipeline integrity or railroad integrity, we feel very confident in those products.

If you look at Chemsil and Chemtec, it's silicone-based products that are there for shine, that -- again, we're looking at sulfate-free products that go directly in line with our Iselux.

So a lot of the things that we brought on really are environment friendly, but also add to our current portfolio and enhances our current portfolio, and gives us the ability really to increase our R&D and increase our -- or really focus on new molecules. .

Our next question today comes from Ivan Marcuse of KeyBanc. .

This is Eugene Fedotoff sitting in for Ivan. Question about Octane, you provided guidance on operating income for this segment.

How about the sales, do you think you can return to $10-plus million per quarter in that business going forward? Or sales will be significantly lower than that?.

Yes, I mean, for Q2, our expectation is that we'll be sort of around up to $10 million to $12 million of sales. Beyond that, it's a little bit difficult to give you any more visibility. But for the full year, we would expect to be somewhere around that $35 million to $40 million of sales for the full year. .

And could you provide details on how much acquisitions contribute to EBIT for each segment?.

Yes, we don't going into that -- in that level of detail on this call. And -- but they are all accretive and they've all improved our EBIT, no doubt about it, across both Bachman and Chemsil, Chemtec. .

Fair enough.

And any changes in raw material costs year-over-year for Fuel or Performance Chemicals?.

What we're seeing, as always, is that there's some ups and downs in our raw material costs. Broadly, we've been able to manage those really well. We've not had particular impacts on our margins because of any increases, and we're allowed to pass those through where it's been appropriate. So I would say over the year, it's broadly neutral for us. .

Okay.

And just a last question, what are your CapEx expectations going forward for this year?.

For the core business, for our assets, it's around about $10 million. But we will be applying or continuing to apply information system globally. We've rolled out the Americas and will continue to rollout into EMEA through this year and into the early part next year.

So in total, we'll probably expand -- expect to spend somewhere between $15 million to $20 million across the group in total. .

$15 million to $20 million?.

Yes. .

[Operator Instructions] We will now move to our next question from Chris Shaw of Monness, Crespi. .

Can I ask about Performance Chemicals? It looks like the underlying sales from the preexisting business is not Chemsil or Chemtec. I think you said volumes were down 1%. Could you just give me some color around the sort of 3 parts that, that business had, the Personal Care stuff versus Fragrance versus Polymers.

I assume Personal Care was still growing?.

Personal Care, Polymers, and Fragrances. Our Polymers business has had some difficult quarters in the last year, but we were quite pleased with the way it performed in Q1. Revenues were about where we expect them to be, but our profitability, our gross margin was a little bit higher, which was pleasing.

Fragrances was essentially flat, both in terms of revenues and also in terms of margins. But our core Personal Care businesses, which is where our focus is and all our energy goes, that business has continued to grow at double digits.

And then on top of that, we've got the acquisition growth, which is all in Personal Care as well, which is very pleasing. And that's why we've have been able to expand the gross margins, Chris, in this business, in this quarter. .

I think, just to add a little color to that, Chris, and that's a good explanation by Ian, is we have come out to all the investment community, our shareholders, and obviously, our own employees, and talked about how we're going to fundamentally change the Performance Chemicals business. And we focused on Personal Care.

And as you can see now, and you'll see through the numbers and moving forward, that, that focus has really paid off. .

Now we're at about 50% of the business is now Personal Care. And the goal has always been to get that up to the 75% range because it has better margin base to it. And I believe that we're getting close to doing that with some of the organic growth and also some of the focus in the future of what we'll looking at in acquisitions.

But the strategy that we put forth over the last 3 years has definitely paid off. .

I forget, is there any sort of shared facilities that would make, maybe, selling the Polymers business difficult? Or would that be something you might look into eventually?.

No. I mean, the Polymers business, really, the reason why we acquired that business originally was for the polymers for Fuel Specialties for coal flow purpose [ph]. And whatever we don't sell on the Fuel Specialties side goes out the door to the hot-melt markets or whatever wax markets might be available to us at that time.

So it's really not a shared asset. It's a shared asset in regards to where the actual product goes, but not in regards to manufacturing. .

Okay. And then just looking at the loss you reported in Octane on the essentially 0 sales. Is that -- would that be sort of reflective of what stranded cost would be, if the whole of the segment -- your last customer did switch away, and got 0 revenues for a full year.

Would that sort of an $8 million run rate -- or $2 million a quarter, would that be, I guess, representative of what sort of the leftover cost? Or could those be removed once the segment actually or the business were shutdown?.

Yes, we'd expect still to remove the vast majority of those costs, Chris. .

As there are no further questions, that will now conclude today's question-and-answer session. I would now like to hand the call back to Patrick Williams for any additional or closing remarks. .

Thank you, all, for joining us today and thanks to our shareholders 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. We look forward to meeting up with you again. Have a great day. Bye-bye. .

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