Innospec Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Unaudited interim results; amounts in U.S. dollars unless noted.
Business context and results
Innospec reports four segments: Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives. Octane Additives is expected to decline as its sole remaining refinery customer transitions to unleaded fuel.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $362.4m | $358.1m | $750.7m | $718.8m |
| Gross profit | $111.1m | $102.8m | $228.9m | $207.3m |
| Gross margin | 30.7% | 28.7% | 30.5% | 28.8% |
| Operating income | $31.7m | $28.3m | $67.9m | $57.2m |
| Net income | $22.3m | $21.8m | $51.0m | $44.0m |
| Diluted EPS | $0.90 | $0.89 | $2.07 | $1.79 |
Financial position, cash flow and liquidity
- Six-month operating cash flow was $63.2m, versus $0.3m in the prior-year period. Capital expenditures were $16.2m, compared with $10.5m.
- Cash was $106.1m at June 30, 2019, down from $123.1m at December 31, 2018. Adjusted working capital, a company-defined non-GAAP measure, was $290.3m, up from $280.4m.
- Debt was $158.0m, including $76.0m drawn on the revolving credit facility and an $82.5m term loan, compared with $207.6m at year-end 2018. Finance lease obligations were $2.2m. The company repaid $50m net on its revolving facility during the first six months.
- Current assets were $650.5m and current liabilities $303.7m. Adoption of lease accounting (ASC 842) added $36.0m of operating-lease right-of-use assets and $36.0m of operating-lease liabilities; the company said adoption materially affected the balance sheet but not the income statement.
Changes versus prior-year period
- Q2 sales rose 1%, gross margin increased 2.0 percentage points, and operating income increased 12%. For the first six months, sales rose 4%, gross margin increased 1.7 points, and operating income increased 19%.
- Oilfield Services was the largest growth driver: Q2 sales increased 29% to $122.5m and six-month sales increased 26% to $236.7m, reflecting higher customer activity and sales of higher-margin products.
- Performance Chemicals sales declined 12% in Q2 and 8% for the half, with lower volumes and unfavorable mix/exchange effects; improved margins reflected product mix, raw-material costs and improvement projects.
- Fuel Specialties sales were nearly flat in Q2 and rose 4% for the half. Octane Additives sales fell 81% in Q2 and 82% for the half, consistent with the expected customer transition.
- Six-month net income increased to $51.0m from $44.0m. Lower interest expense helped, while the adjusted effective tax rate rose to 26.4% from 24.8% as a smaller share of profits came from low-tax jurisdictions.
Outlook, risks and unusual items
- The filing provides no specific quantitative earnings or revenue guidance. Management says Octane Additives sales are expected to keep declining as the remaining customer changes fuel requirements.
- A network security incident on June 27 disrupted access to systems used for order entry, shipping, payments and production scheduling. Manufacturing continued safely and largely without interruption; some business processes were restored or handled manually. The company reported no evidence that customer, supplier or employee information was accessed or extracted, and said the incident had not materially affected Q2 results. It was still assessing the financial impact, anticipated future costs, and insurance coverage, while warning that order delays could continue.
- Management concluded disclosure controls and procedures were ineffective at June 30 because the incident revealed a material weakness in IT infrastructure controls. Management performed additional procedures to validate reported results and said remediation was in development; the weakness had not been remedied as of the filing date.
- Plant closure provisions totaled $49.4m, including $5.3m due within one year. Unrecognized tax benefits, interest and penalties totaled $14.6m; the company said recognition would affect its effective tax rate. It reported no material pending legal proceedings and $4.6m of unrecognized guarantees.
- The company paid $12.2m in dividends in the first half. Its previously authorized $100m share-repurchase program had no repurchases during the period; purchases reported in Q2 were related to employee stock-option exercises.
Important facts for investors to verify
- Progress in restoring and securing IT systems, remediation of the material weakness, and any effects on order fulfillment, financial reporting or insurance recoveries.
- Whether Oilfield Services growth and margin improvement continue, and whether Performance Chemicals sales stabilize.
- The pace and financial effect of the remaining Octane Additives customer’s transition to unleaded fuel.
- Cash conversion, working-capital trends, debt repayment and the implications of the higher adjusted effective tax rate.
- Potential outcomes of tax examinations, plant-remediation obligations and other disclosed contingencies.