David Jones - VP, General Counsel, Chief Compliance Officer & Corporate Secretary Patrick Williams - President, CEO & Director Ian Cleminson - EVP & CFO.

Jonathan Tanwanteng - CJS Securities Curtis Siegmeyer - KeyBanc Capital Markets Sean Milligan - Johnson Rice & Company.

Good day, and welcome to the Innospec Second Quarter 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. David Jones, Vice President, General Counsel and Chief Compliance Officer. Please go ahead, sir..

Thank you. Good day, everyone. This is David Jones, I'm Vice President, General Counsel and Chief Compliance Officer at Innospec. Thank you for joining our second quarter 2018 financial results conference call. This call is being recorded. As you know, late yesterday, we reported our financial results for the quarter ended June 30, 2018.

The press release is posted on the company's website, www.innospecinc.com. The slide presentation on the results is now available on our website, and both an audio webcast and the slide presentation will be archived on the website for six months.

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 that are 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. Turn to Slide 3, which is -- covers the use of non-GAAP financial measures.

In our discussion today, we've also included some non-GAAP financial measures, a reconciliation to the most directly comparable GAAP financial measures is contained in our earnings release, a copy of which is available on the Innospec website. Slide 4 is the agenda.

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'll turn it over to you, Patrick..

Thank you, David, and welcome, everyone, to Innospec's Second Quarter 2018 Conference Call. Our results for the second quarter show that Innospec's business and long-term strategy continues to develop right in line with our expectations.

Our core businesses all showed good growth in both revenues and operating income compared to the same quarter last year. As expected, Octane Additives was markedly lower in the same quarter a year ago and this impacted EPS by $0.28 year-over-year.

If we look at the underlying performance of the businesses excluding Octane Additives, we delivered a 17% year-over-year improvement in adjusted EPS from $0.69 to $0.81. We also experienced a substantial increase in our share price, which gained 12% in just 1 quarter.

While this is great reward for our shareholders, we do have accrued share-based compensation, which rises in parallel. This increase in cost was $0.10 of EPS equivalent year-over-year.

Once again, I am delighted to report the progress in our Performance Chemicals business where we have delivered a 13% improvement in revenue, and we have also improved margins through better sales of our technically advanced products.

These factors have combined to push Performance Chemicals' operating income up 49% and adjusted EBITDA up 36% compared to the second quarter of 2017. Fuel Specialties continued its solid revenue progress. Sales were up by 11%, with good contributions from all regions.

The business environment is still challenging, with higher raw material costs being driven by increased crude oil prices. Additionally, higher prices for both transportation and labor has consequently put some pressure on margins. However, good cost control has ensured that we have delivered operating income broadly similar to 2017.

We enter a period of raw material stability. We expect our pricing to improve margins from the current low end of the range. Our focus in Oilfield Services remains to improve profitability.

Continued customer activity and market share gains driven by our excellent technology and service have underpinned revenue growth, which is up 25% in the same quarter last year. Raw materials, transportation and labor costs have continued to rise and tempered the improvement in operating income.

In spite of these headwinds, operating income is up 11% on last year and up 37% over the first quarter 2018. We have stabilized the business and we will continue to see margin improvement. In Octane Additives, slower sales were exactly as we anticipated.

The business delivered a single order of $8.7 million of revenue, which was down 58% on an extremely strong comparative quarter. Consequently, operating income was down almost 60% compared to 2017. We expect a further order of a similar size in the third quarter and potentially one more later in the year.

Our portfolio continues to deliver the plan, and our strategy leaves us all well placed to drive further growth in the coming years. Now I will turn the call over to Ian Cleminson, who will review our financial results in more detail. Then I will return with some concluding comments. After that, we will take your questions.

Ian?.

Thanks, Patrick. Turning to Slide 7 of the presentation. The company's total revenues for the second quarter were $358.1 million, a 10% increase from $326.3 million a year ago.

The overall gross margin decreased 3.5 percentage points from last year to 28.7%, with a lower contribution from Octane Additives and with margins at the low end of the expected range in both Fuel Specialties and Oilfield Services. Adjusted EBITDA for the quarter was $43.7 million, an 11% decrease compared to last year.

Our GAAP earnings per share were $0.89, including special items, the net effect of which decreased our second quarter earnings by $0.11 per share. A year ago, we reported GAAP earnings per share of $1.06, which included an adverse impact from special items of $0.10.

Excluding special items in both years, our adjusted EPS for the quarter was $1, a 14% decrease from $1.16 a year ago. However, Patrick mentioned, excluding Octane Additives from both quarters, our underlying growth in EPS remains strong, increasing 17% from $0.69 a year ago to $0.81, reflecting the strength in our core businesses. Turning to Slide 8.

Revenues in Performance Chemicals for the second quarter were $118.9 million, up 13% from $104.9 million a year ago, with contributions from all product lines and regions, particularly in the Americas. Good customer demand for our technically advanced products helped drive our volume increase of 6% and there was a positive currency impact of 7%.

As we anticipated, we have been able to deliver further improvements in gross margins, up 3.4 percentage points on the same period last year. Operating income was up 49% from last year at $9.7 million. Moving on to Slide 9.

Revenues in Fuel Specialties for the second quarter were $134.2 million, an 11% increase from the $121.3 million reported a year ago. Customer adoption of our new technologies drove a 10% increase in volumes and there was a positive currency impact of 6%. These impacts were partly offset by an unfavorable price mix effect of 5%.

All regions delivered improved revenue performance, with the Americas leading the way with 17% growth and also a very creditable uplift of 9% from both EMEA and Asia Pacific. As Patrick indicated, gross margins have been affected by rising costs under the low end of the normal range.

Comparative quarter last year was very strong, and therefore, margins are down 4.1 percentage points at 33.2%. Operating income for the quarter was $23.7 million, broadly flat on the comparative quarter. Moving on to Slide 10. Our Oilfield Services business continues to have mixed results.

Revenues continue to grow well as customer activity is strong and we have improved our market share. Revenues of $95 million were up 25% on the same quarter last year, with a focus of growth being in stimulation and completion. Volumes were up by 17% and there was a favorable price mix of $0.08.

However, as we have previously indicated, cost pressure in this business continues to depress gross margins, which were 3.7 percentage points down sequentially. Operating income of $4.1 million was up 11% on the same period last year, and we expect further improvements in future quarters. Moving on to Slide 11.

In Octane Additives, revenues for the quarter were $10 million compared to $24 million a year ago. Gross margin was 59%, an operating income of $5.2 million compared to $12.8 million in last year's second quarter. We completed the latest order from our last remaining Motor Gasoline customer.

While we have no further confirmed orders on hand, our expectation is that there will be further orders in the second half of the year. Beyond this, we have no visibility but we will continue to update you on these quarterly calls. Turning to Slide 12.

Corporate costs for the quarter were $14.4 million compared to $12.4 million recorded a year ago, driven by higher stock-based compensation accruals as a result of the 12% increase in the Innospec share price from the previous quarter.

The effective tax rate for the quarter was 26.1% compared to 25% last year, driven by the geographical location of taxable profits. We now expect the full year effective tax rate to be 26%. Moving on to Slide 13. Net cash provided by operating activities in the quarter was $2.3 million compared to $9 million a year ago.

We have indicated that cash generation will be better in the second half of the year, and early signs are encouraging. Capital expenditure of $6.7 million included the investments in our new drag reducing agents. In the quarter, the company also distributed $7.7 million to shareholders for the semiannual dividend.

As of June 30, 2018, Innospec have $66 million in cash and cash equivalents and total debt of $228.2 million, ensuring that our net debt position remains under 1x trailing 12 months adjusted EBITDA. And now, I'll turn it back over to Patrick for some final comments..

Thanks, Ian. The second quarter has produced a solid business performance while also highlighting some of the challenges that we continue to face in the current inflationary environment.

Excluding Octane Additives, we have delivered excellent revenue growth of 15% from all our core businesses, which demonstrates that our research technology programs continue to rise to the challenge of changing market conditions.

Performance Chemicals continued its strong sales performance from delivering great margin improvement over the same period last year. Fuel Specialties revenues were much improved, and we have programs to recover margins in light of raw materials increases.

Oilfield Services continues to post strong sales growth and we expect further margin and operating income improvements in the coming quarters. We have maintained a very strong balance sheet, with net debt remaining in a very comfortable position, below 1x adjusted EBITDA.

We expect cash generation to be stronger in the second half of the year, and there's early evidence that this one indeed be the case. We are in a strong position to balance our capital priorities, allowing us to invest in a number of organic growth projects, including our entry into the Drag Reducer market.

This project is still on track and we are on schedule to run customer trials in the near future. Our balance sheet will allow us to participate in acquisition projects where we believe we could create shareholder value, but we will continue to be cautious where multiples remain very high.

With a very solid base, a strategy which continues to deliver and clear opportunities for further improvement, we feel confident about the future. Now I will turn the call over to the operator, and Ian and I will take your questions..

[Operator Instructions]. We have our first question from Jon Tanwanteng from CJS Securities..

It seems to me it was actually a pretty nice quarter even with the margin headwinds actually back up the stock comp.

Can you just give us a little color as to what you expect going forwards, whether price increases and cost reductions are going to expand margins in each of those businesses as you go forward into Q3?.

Yes, Jon, good question. We agree with you, by the way. We thought it was a pretty solid quarter. We have been putting in price increases throughout the market. There's obviously been a trend towards inflationary times right now in all of our businesses. But we have plans in place.

We do expect margin improvement in Q3 and Q4 in all three of our businesses. Now we're not talking massive margin improvements, but we're talking 1% here and there in each of the businesses. So yes, plans are in place. And I believe you'll see improvement in Q3 and definitely improvement in Q4 as well..

Great, that's very helpful.

And then just on the drag reducing agent opportunity, have you quantified what that might look like in 2019 and beyond and kind of the run rate to get there?.

Yes, it's difficult. We will start running trials more than likely in the latter part of this year, early part of next year. So it's difficult to kind of quantify what we think the market size will be for our product. But the overall market is about a $400 million to $500 million market globally.

And our expectations is to get a fair share and not overburden the market as well..

Okay, great. And then just in terms of Octane.

Are you thinking similar size to what you've seen already this year? Or is there more to go in terms of what your new plan is likely to meet?.

Yes, I would say the order in Q3 is going to be similar as Q2. And in probably Q4, you might see a similar size or maybe a little bit bigger is our expectations..

Our next question comes from Curt Siegmeyer of KeyBanc Capital Markets..

If I could just follow up on the margins, more specifically, the Fuel Specialties.

If you kind of think about the progress you expect to make there and the issues with raw material headwinds and so forth, is there an expectation that maybe given the lag with pricing, kind of price versus cost, should we maybe expect up margins in line with last year by the end of the year? Or some of the other logistic and freight costs and whatnot kind of keep that from being the case?.

Yes, you're going over a tough comparison over last year. But we do see -- and we've mentioned this more than once that we were at the top end of the range last year. And the typical range for this business is in a net 33% to 35%, and we would expect Q3 to Q4 to get back into that 33% to 35% range, which is really the norm in this business.

When you get low crude prices, obviously, prices jump, margins jump up. And when you got higher crude prices and inflationary pressures, which we have right now, which is kind of a double-edged sword there, prices -- we've got some pressure on pricing.

But overall, we should see margins normalize back down to that 33%, 34% range for the remainder of the year..

Okay, great. And then just one on the corporate costs.

How should we think about that line item for the rest of the year relative to last year, given the $2 million increase in the quarter?.

Yes, Curtis, it's Ian. I think roundabout $12 million per quarter will be our normalized run rate. As we said earlier on the call, we've had a little bit of an increase there from the share-based comp accruals that we've made, but normalized share price, I would say, is roundabout $12 million..

Our question is from Scott Bloominghall [ph] of Emerald Advisers..

Patrick, you mentioned that you had taken actions during the quarter in order to improve margins.

Might you be able to elaborate on what some of those were?.

Yes. I mean, recovery and transportation costs that have spiraled out of control. Obviously, charging for labor costs, which we've had similar issues in the Oilfield Services, and more importantly, the lag on raw materials, and that affected all three of the businesses.

And as you know, we've had a tight market in raw materials and an increase in crude price, which have put a lot of pressure on pricing at this point. So it's really been an exercise of addressing all three of those inflationary points.

And I think the raw materials is one of the most important that we've had typically a 3 to 6 month lag and we've seen that in this quarter. So we should start to catch back up marginally in Q3 and more so in Q4..

Okay, great. That's really helpful. And you also mentioned that you've seen -- I think maybe Ian mentioned that there's early evidence of improving cash flow in the second half and maybe you can give us an idea as to what that evidence might be..

Yes, Scott. We've certainly seen in July a real great cash inflow from all our businesses. As you can -- as we've said earlier in the call, we've had to expand our revenues of how to invest in working capital and that's a fair amount of our cash.

We're very nicely set now for a bigger cash inflow in the second half of the year, very similar to where we were in 2017. And we expect to very highly positive in the back half of the year. So we're pretty pleased with what we've seen so far in July..

Ian, is that a trend or is that kind of a seasonal thing that we should continue to expect maybe using a little bit of working capital in the first half and pulling some cash out of that in the second half? Or this year a little bit different because of what you've been struggling with from a raw material perspective?.

Yes. I think it's partly a trend. This time last year, we were in a very similar position but that was more down to the acquisition that we've made. This time around, it's about the growth in the business, the organic growth that we've seen, all very positive things which we would have to fund.

So I think where we are right now, we're getting great momentum on this revenue line, we're here to form that business, we're here to make profitable growth and that's what we're going to do. So as long as that continues and we can make great profits out of that revenue, we'll continue to form the business where we need to be.

We're mindful of cash, but we won't stop the business. It's very important that we continue to grow where we can. So whether it's at a trend or not, we'll wait and see. But we're in a good cash position..

Okay, super. And I guess my last question is for Patrick, I know that you're investing in the Drag Reducer.

Should we expect those types of investments to taper off a little bit here coming into the second half? Or investment in that were still kind of in the meat of the investment cycle?.

Yes. Specific to DRA, we're probably still in the meat of the cycle. I would say you'll start seeing the trail off in Q4. You'll still see some movement in Q3 but Q4 is when you'll start seeing the trail-off on that investment..

[Operator Instructions]. Our next question comes from Sean Milligan of Johnson Rice..

Can you maybe talk a little bit about Fuel Specialties, the year-over-year revenue progression? I know for a fact this year has been very strong.

Can you maybe address it in terms net of price? And specifically, kind of what's driving that trend?.

Yes. I mean, if you look at it, it's being pretty balanced across all regions but we did see the Americas come back well in this quarter. And we expected that. But it's been a pretty good balance, a good -- a pretty good balance of products as well and product mix, which is pleasing to us. It's not just one product that brought the market back.

And I think the technology gains in this business, which is constant, has really helped in the quarter and I think it's going to help us moving forward into 2018 and '19 as well. Especially when the IMO 2020 comes in and gasoline direct injection comes into play, we have technologies for both of those markets.

And I think that, credit to our technology center, that's was helping the growth right now..

Okay. And then -- that's a good [indiscernible] into the second question.

In terms of [indiscernible] timing of growth opportunities [indiscernible] DRA, gasoline and then IMO, is that the right order in terms of timing? And then can you maybe update us where we are in the second part of that on the gasoline side?.

Yes. I mean, if you look at it, those are probably the three, what I would say, market-changing technologies right now. And so which one comes first, obviously, IMO is 2020; GDI, just a function of market timing. So in DRA, will be sometime where we get marketable and commercial business sometime in early 2019.

So all of the -- these are the three plays moving forward for the next year, and our goal is to obviously introduce more new products for new markets in 2019 and 2020. That's what we're working on right now..

It appears there are no further questions at this time. Mr. Patrick Williams, I would like to hand the conference back to you 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 today, please give us a call. We look forward to meeting up with you again to discuss our Q3 2018 results in November. Have a great day..

This concludes today's call. Thank you for your participation. You may now disconnect..