Innospec Inc. — Q3 2016 Form 10-Q
Business context and period: Unaudited results for the three and nine months ended September 30, 2016, compared with the same 2015 periods. The company reports four segments: Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives. Prior-period segment amounts were recast to reflect the revised structure.
Financial results
Amounts in USD millions, except per-share data and percentages.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | 205.5 | 254.2 | 645.6 | 766.3 |
| Gross profit | 79.2 | 90.4 | 240.9 | 259.7 |
| Gross margin | 38.5% | 35.6% | 37.3% | 33.9% |
| Operating income | 18.9 | 41.2 | 73.1 | 122.0 |
| Net income | 11.4 | 35.6 | 59.2 | 88.0 |
| Diluted EPS | $0.47 | $1.45 | $2.42 | $3.57 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | 86.8 | 90.6 |
- Q3 sales fell 19%, operating income 54% and net income 68% year over year. Nine-month sales fell 16%, operating income 40% and net income 33%.
- Q3 gross margin improved 2.9 percentage points; the nine-month margin improved 3.4 points. Lower sales volumes reduced gross profit dollars despite the stronger margin.
- Nine-month cash from operations was $86.8 million. Capital expenditures were $12.2 million; dividends paid were $8.1 million and share repurchases were $8.2 million.
- Cash and cash equivalents were $167.1 million at September 30, versus $136.9 million at year-end 2015. Debt under the revolving facility was $143.0 million, up from $133.0 million; finance lease obligations were $4.5 million. The $200 million revolving facility runs through November 2020. Cash less revolving debt was $24.1 million.
- Current assets were $479.2 million and current liabilities $159.0 million. Adjusted working capital, a company-defined non-GAAP measure, was $160.4 million, down from $167.1 million at year-end.
Material changes and segment performance
- Oilfield Services: Q3 sales declined 37% to $49.7 million; nine-month sales declined 39% to $132.4 million. Management cited lower customer activity, especially well completions, following lower oil prices. Nine-month segment operating loss was $7.1 million versus $13.8 million income in 2015; cost reductions partly offset the downturn.
- Fuel Specialties: Q3 sales declined 6% to $114.4 million, while operating income rose to $24.1 million from $21.6 million. Management attributed margin improvement to product mix and currency-related cost benefits; Americas volumes were pressured by refinery crude-slate changes.
- Performance Chemicals: Q3 sales rose 9% to $36.8 million and operating income rose to $4.2 million. Higher Personal Care volumes and mix supported margins; expenses included a $1.0 million commercial legal settlement with a distributor.
- Octane Additives: Q3 sales fell 77% to $4.6 million because of customer-demand timing. Management expects the segment to decline as its sole remaining refinery customer transitions to unleaded fuel.
- Corporate costs increased $5.9 million in Q3 year over year, including ERP deployment costs, acquisition-related professional fees and higher compensation. The nine-month increase was $13.0 million.
Outlook, risks and unusual items
- The filing provides no quantified earnings or revenue guidance. Management described active growth-seeking in Fuel Specialties, Performance Chemicals and Oilfield Services, but highlighted pressure on Oilfield Services from oil-and-gas activity and the expected decline in Octane Additives.
- On October 25, 2016, after quarter-end, the company signed an agreement to acquire Huntsman’s European Personal Care and Home Care business for approximately $200 million, subject to adjustments and customary closing conditions. Closing was expected in Q4 2016.
- Acquisition-related contingent consideration fell to $4.3 million from $54.6 million at year-end; the company paid $44.0 million during the first nine months. Fair-value credits were $2.3 million in Q3 2016 and $6.3 million for the nine months, substantially below the prior-year credits. The valuation depends on Independence Oilfield Chemicals’ forecasts and oil-and-gas activity.
- Q3 other net expense was $5.0 million, primarily foreign-currency translation losses in European businesses. Unhedged foreign-currency forwards generated a $3.2 million gain in the first nine months.
- The company reported $39.2 million in plant closure provisions, including environmental remediation costs, of which $5.0 million was current. It reported no material pending legal proceedings; guarantees not recorded as liabilities totaled $3.7 million.
- Management said there had been no material change in risk factors since the prior quarter. Key exposures include oil-and-gas market conditions, foreign exchange and interest rates, environmental obligations, tax examinations and the execution and financing of the announced acquisition.
- Disclosure controls were assessed as effective at September 30, 2016. The filing notes that results for the interim period are not necessarily indicative of full-year results.
Investor verification priorities
- Track Oilfield Services demand, pricing and operating performance as oil-and-gas activity changes.
- Verify the timing, final consideration, funding and integration progress of the proposed Huntsman business acquisition.
- Review the remaining contingent consideration and underlying Independence forecasts, including sensitivity to oil prices and customer activity.
- Monitor whether stronger gross margins translate into operating income and cash generation given higher corporate costs and weaker sales.
- Assess environmental closure provisions, foreign-currency exposure, tax audit outcomes and the concentration of cash held outside the United States.