Innospec Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Unaudited results; dollar amounts are in millions unless stated otherwise. Innospec reports four segments: Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives. The company changed its segment structure during the quarter and recast comparative segment figures.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $228.0 | $242.9 | $440.1 | $512.1 |
| Gross profit | $85.5 | $87.5 | $161.7 | $169.3 |
| Gross margin | 37.5% | 36.0% | 36.7% | 33.1% |
| Operating income | $28.6 | $57.4 | $54.2 | $80.8 |
| Income before taxes | $36.4 | $51.8 | $60.9 | $75.7 |
| Net income | $28.9 | $34.5 | $47.8 | $52.4 |
| Diluted EPS | $1.18 | $1.40 | $1.95 | $2.12 |
| Operating cash flow | Not separately stated | Not separately stated | $57.0 | $55.1 |
- Q2 revenue declined 6% year over year; first-half revenue declined 14%. Gross profit fell 2% in Q2 and 4% in the first half, while gross margins improved in both periods.
- Operating income fell 50% in Q2 and 33% for the first half. A key comparison effect was the contingent-consideration fair-value credit: $2.4 in Q2 2016 versus $26.6 in Q2 2015, and $4.0 for the first half versus $23.1. These credits are not recurring operating sales.
- Other net income was $8.5 in Q2 and $8.2 for the first half, chiefly reflecting foreign-currency translation and forward-contract gains; the comparable 2015 periods recorded net expenses. Q2 effective tax rate was 20.6% versus 33.4%; first-half rate was 21.5% versus 30.8%. Management’s adjusted effective tax rates, a non-GAAP measure, were 20.5% and 20.3%, respectively, compared with 26.9% and 25.8%.
Segment trends
- Fuel Specialties: Q2 sales rose 6% to $129.3; first-half sales declined 5% to $252.7. First-half operating income was $48.1 versus $49.1. Regional volumes and mix varied; management cited weaker Americas demand, warmer winter conditions and refinery crude-slate changes, alongside growth in other markets.
- Performance Chemicals: Q2 sales declined 20% to $35.3 and first-half sales declined 23% to $70.0, partly reflecting the prior-year disposal of Aroma Chemicals. First-half operating income was $9.1 versus $9.5. Higher Personal Care contribution supported improved gross margins.
- Oilfield Services: Q2 sales fell 34% to $46.5 and first-half sales fell 40% to $82.7. The segment recorded operating losses of $1.6 in Q2 and $7.1 for the first half, versus profits of $5.0 and $6.6 in the comparable periods. Management attributed lower activity, particularly in well completion, to the oil-price decline; cost reductions and sales mix supported margins.
- Octane Additives: Q2 sales were $16.9 versus $6.5; first-half sales were $34.7 versus $18.7. The increase reflected demand timing from the segment’s sole remaining refinery customer and favorable production variances.
Cash, debt and liquidity
- Cash and cash equivalents were $153.2 at June 30, up from $136.9 at year-end; $144.4 was held by non-U.S. subsidiaries. Short-term investments were nil, compared with $4.8 at year-end.
- First-half operating cash flow was $57.0; capital expenditures were $7.5. Investing activities used $1.0 and financing activities used $39.3, including $44.0 paid for acquisition-related contingent consideration, $8.1 in dividends and $8.2 in share repurchases. The company drew $28.0 and repaid $7.0 under its revolving facility.
- Revolving-credit debt was $154.0, up from $133.0 at year-end, under a facility with a stated maximum borrowing capacity of $200.0 through November 2020. Finance lease obligations were $3.9. Cash was slightly below revolving debt before considering leases.
- Current assets were $463.8 and current liabilities $149.2. Adjusted working capital, a company-defined non-GAAP measure, was $173.8 versus $167.1 at year-end.
- Total liabilities were $391.6; total equity was $639.5. Plant-closure provisions, principally for remediation at Ellesmere Port in the U.K., totaled $38.6, including $5.7 due within one year.
Outlook, risks and unusual items
- The filing provides no numerical full-year earnings or revenue guidance. Management noted that Octane Additives is expected to decline in the near future as its remaining refinery customer transitions to unleaded fuel.
- Oilfield Services performance remains sensitive to customer exploration, development and production activity, which management linked to oil prices. The related Independence acquisition contingent consideration was valued using forecast EBITDA and free cash flow through October 31, 2016.
- In a subsequent event, Innospec entered an agreement to acquire Huntsman’s European Personal Care and Home Care business for approximately $200 million, subject to adjustments, regulatory approvals and employee consultation. Closing was expected in Q4 2016. A commitment letter provided for up to $150 million of term-loan financing.
- The company identified potential Brexit-related effects, including trade restrictions, regulatory complexity, market volatility and currency fluctuations. It also cautioned that most cash is held overseas and that repatriation could result in additional U.S. tax; no repatriation was expected in the foreseeable future.
- There were no material pending legal proceedings disclosed. Unrecognized tax benefits and related interest and penalties totaled $3.5; the company said pending U.S. state and German tax audits were not expected to materially affect its financial position. Guarantees not recorded as liabilities totaled $3.7.
- Disclosure controls were assessed as effective at June 30, 2016, with no material second-quarter change in internal control over financial reporting reported.
Most important facts for investors to verify
- Whether the sharp year-over-year decline in operating income persists after separating contingent-consideration fair-value credits and foreign-exchange gains or losses.
- Oilfield Services demand, operating losses, and the assumptions used to value the Independence contingent consideration.
- Cash-flow durability and revolver availability, including borrowing terms and any applicable restrictions not detailed in the supplied filing text.
- Funding, regulatory and closing conditions for the proposed approximately $200 million Huntsman business acquisition, and the planned $150 million term-loan financing.
- Exposure to Brexit-related currency and trading effects, overseas cash repatriation taxes, and environmental remediation costs.