Innospec Inc. — Q1 2017 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2017, compared with the three months ended March 31, 2016. Innospec reports four segments: Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives. Performance Chemicals results include the European Differentiated Surfactants business acquired from Huntsman on December 30, 2016.
Financial performance and condition
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Net sales | $294.3 million | $212.1 million; up 39% |
| Gross profit / margin | $90.9 million / 30.9% | $76.2 million / 35.9% |
| Operating income | $26.4 million | $25.6 million |
| Income before tax | $23.2 million | $24.5 million |
| Net income | $17.2 million | $18.9 million |
| Diluted EPS | $0.70 | $0.77 |
| Effective tax rate | 25.9% | 22.9% |
| Operating cash flow | $(19.9) million | $6.7 million |
| Capital expenditures | $6.7 million | $3.1 million |
| Cash and cash equivalents | $45.4 million | $101.9 million at Dec. 31, 2016 |
| Debt, net of deferred finance costs | $239.0 million | $268.8 million at Dec. 31, 2016 |
Sales growth was concentrated in Performance Chemicals ($94.5 million, up 172%) and Oilfield Services ($66.5 million, up 84%); Huntsman was a major contributor to Performance Chemicals growth. Fuel Specialties sales rose 2% to $126.4 million. Octane Additives sales fell 61% to $6.9 million. Segment operating income was $26.8 million for Fuel Specialties, $6.0 million for Performance Chemicals, $3.0 million for Oilfield Services and $2.0 million for Octane Additives.
Gross margin declined five percentage points, principally reflecting the lower-margin Huntsman business and segment mix. Operating income was slightly higher, but net income and EPS fell, in part alongside higher net interest expense ($2.2 million versus $0.8 million) and a higher effective tax rate. Q1 included a $1.8 million foreign-exchange loss on liquidation of a subsidiary.
Operating cash use reflected working-capital demands, including the Huntsman acquisition and increased receivables and inventory. Adjusted working capital, a company-defined non-GAAP measure, increased $57.1 million to $237.6 million; management attributed approximately $29 million of the movement to Huntsman. Cash fell by $56.5 million during the quarter, including a $30 million repayment on the revolving credit facility. At quarter-end, borrowings were $131 million on the revolver and $110 million on the term loan; finance lease obligations were $4.7 million. The revolving facility provides up to $200 million through November 2020.
Outlook, commentary, risks and unusual items
- The filing provides no specific full-year earnings or revenue guidance. Management notes that Octane Additives is expected to decline as its remaining refinery customer transitions to unleaded fuel.
- Management linked Oilfield Services growth to increased customer activity following higher oil prices in late 2016; volumes rose 115% year over year, partly offset by adverse price and product mix.
- Huntsman purchase accounting remained provisional at March 31, 2017. A measurement-period review increased acquired assets and reduced goodwill by $39.3 million; final purchase price and valuation remained unsettled.
- Management expects to complete implementation of internal controls for the acquired Huntsman operations in 2017. Disclosure controls were assessed as effective at quarter-end.
- The company reported no material pending legal proceedings and no material changes to the risk factors described in its 2016 Form 10-K. It disclosed $4.0 million of contingent guarantees and $40.6 million of plant-closure provisions, principally associated with remediation at its Ellesmere Port site.
- A state tax examination covering 2012–2014 was not expected to result in a material financial-position change. Foreign-exchange, interest-rate, commodity-price, pension, environmental-liability and acquisition-integration risks remain relevant. Most cash was held by non-U.S. subsidiaries; the company did not expect to repatriate foreign earnings in the foreseeable future.
Important facts for investors to verify
- How much of reported sales and profit growth reflects Huntsman versus underlying volume, pricing and mix, and whether the acquisition’s provisional purchase accounting changes.
- Whether working-capital investment, particularly receivables and inventory, converts into operating cash flow; monitor segment collection and inventory days.
- Whether Oilfield Services demand and margins are sustainable, and the pace of the expected Octane Additives decline.
- Debt repayment capacity and sensitivity of interest expense to floating rates, alongside the substantial reduction in cash during the quarter.
- Progress on Huntsman integration and controls, and developments in environmental closure provisions, tax examinations and foreign cash repatriation exposure.