Innospec Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; comparative figures are for 2017. The interim financial statements are unaudited. Amounts are in millions of U.S. dollars except per-share data.
Business context and operating performance
Innospec reports four segments: Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives. Growth in the first three segments was partly offset by the anticipated contraction of Octane Additives as its sole remaining refinery customer transitions to unleaded fuel.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $358.1 | $326.3 | $718.8 | $620.6 |
| Gross profit | $102.8 | $105.1 | $207.3 | $196.0 |
| Gross margin | 28.7% | 32.2% | 28.8% | 31.6% |
| Operating income | $28.3 | $33.5 | $57.2 | $58.8 |
| Net income | $21.8 | $26.1 | $44.0 | $43.3 |
| Diluted EPS | $0.89 | $1.06 | $1.79 | $1.76 |
| Operating cash flow | Not separately stated | Not separately stated | $0.3 | $(10.9) |
- Q2 versus prior year: Sales rose 10%, but gross profit fell 2%, operating income fell 16% and net income fell 16%. The lower aggregate gross margin reflected raw-material cost timing in Fuel Specialties, weaker segment mix and cost pressures in Oilfield Services, and lower Octane Additives sales. Corporate costs also increased.
- First half versus prior year: Sales increased 16%, while gross profit increased 6% and operating income decreased 3%; net income increased slightly. Diluted EPS improved from $1.76 to $1.79.
- Segment sales, Q2 / first half: Fuel Specialties $134.2 / $277.6, up 11% / 12%; Performance Chemicals $118.9 / $242.9, up 13% / 22%; Oilfield Services $95.0 / $187.9, up 25% / 32%; Octane Additives $10.0 / $10.4, down 58% / 66%.
- Performance Chemicals’ margin improved on manufacturing initiatives, higher volumes and favorable mix. Oilfield Services sales benefited from stronger crude oil prices and customer activity, but margin was pressured by customer mix, raw-material pricing, transportation and labor costs. Fuel Specialties faced a lag in passing through rising raw-material costs.
Cash, liquidity and debt
- Cash was $66.0 at June 30, down from $90.2 at year-end 2017. First-half operating cash flow was $0.3, improved from a $10.9 outflow in 2017, but was constrained by working-capital investment, including a $35.8 cash use from receivables and $45.2 from inventory.
- Capital expenditures were $10.5; investing cash outflow totaled $17.1, including $5.8 for the BioSuite acquisition. Financing cash outflow was $7.2, including $10.7 of dividends.
- Current assets were $609.3 and current liabilities $267.3, yielding reported working capital of $342.0. Management’s non-GAAP adjusted working capital was $307.0, up from $245.4 at year-end, primarily reflecting higher receivables and inventory. Inventory rose $42.5 and receivables rose $32.7 from year-end.
- Debt carrying value, including the current portion, was $223.8: $126.0 under the revolving facility and $99.0 on the term loan, net of deferred finance costs. Finance lease obligations were $4.4. Cash less debt was approximately $157.8 net debt, excluding leases; at year-end, the comparable calculation was approximately $128.2.
- The company held $57.1 of cash outside the U.S. and did not expect to repatriate foreign earnings in the foreseeable future. It made its first $3.8 payment toward the U.S. transition tax during 2018; the recorded provisional liability was $47.7, payable over eight years.
Outlook, commentary and risks
- The filing gives no specific earnings or revenue guidance. Management attributed increased working capital partly to expected sales increases in the second half of 2018. Oilfield Services activity was supported by stronger crude prices; Octane Additives demand was expected to continue declining with the remaining customer’s transition to unleaded fuel.
- In May, Innospec acquired BioSuite LLC, a biocide and biostat solutions formulator for oil and gas, for stated total consideration of $9.0, subject to working-capital adjustments. The initial payment was $5.8; a further performance-related payment was anticipated at $3.2 based on the current forecast.
- U.S. tax reform accounting remained provisional, including analysis of the transition tax and GILTI provisions. The company recorded additional unrecognized tax benefits related to Italian tax audits; an indemnification asset was recorded because the former owner is expected to reimburse any resulting liability. Unrecognized tax benefits, interest and penalties totaled $3.1.
- Plant closure provisions were $48.0, principally associated with environmental remediation at Ellesmere Port in the U.K. The filing reports no material pending legal proceedings, while noting that an unexpectedly large aggregate number of claims could adversely affect results. Off-balance-sheet guarantees not recorded as liabilities totaled $4.2.
- Other exposures include foreign-exchange, interest-rate, raw-material cost and credit risks. Foreign-currency forward contracts produced a $1.3 loss in the first half; interest-rate swaps produced a $1.3 gain recorded in other comprehensive income. Management reported no material change in risk factors from its 2017 Form 10-K.
- Adoption of the pension-cost presentation standard recast 2017 comparative operating income downward by $1.2 for Q2 and $2.3 for the first half, with corresponding increases in other non-operating income. The company was evaluating the upcoming lease-accounting standard and expected it to recognize right-of-use assets and lease liabilities.
- Management concluded disclosure controls were effective as of June 30, 2018 and reported no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether segment sales growth—particularly in Performance Chemicals and Oilfield Services—translates into improved margins and operating income, given the Q2 decline in total gross margin.
- Whether elevated inventory and receivables convert to cash in the second half, and whether operating cash flow improves from the near break-even first-half result.
- The pace and financial effects of the Octane Additives decline as the sole remaining customer transitions to unleaded fuel.
- Final U.S. tax-reform accounting, the transition-tax payment schedule, and the resolution or reimbursement of Italian tax-audit exposures.
- BioSuite’s performance against the forecast underlying its contingent payment, and the continuing costs and assumptions behind the $48.0 plant-closure provision.