Business context and reporting period
Innospec Inc. filed this Form 10-K for the fiscal year ended December 31, 2015. The company develops and sells fuel additives, oilfield chemicals, personal care and other specialty chemicals, and tetraethyl lead (TEL) and related remediation services. Its reporting segments are Fuel Specialties, Performance Chemicals and Octane Additives. Quarterly figures below are for Q4 2015, not a separate quarterly filing.
Financial results and liquidity
| Metric | FY 2015 | FY 2014 |
|---|---|---|
| Net sales | $1,012.3 million | $960.9 million |
| Gross profit / margin | $346.0 million / 34.2% | $302.0 million / 31.4% |
| Operating income / margin | $156.3 million / 15.4% | $112.5 million / 11.7% |
| Net income | $119.5 million | $84.1 million |
| Diluted EPS | $4.86 | $3.38 |
| Cash from operating activities | $117.7 million | $106.3 million |
| Cash, cash equivalents and short-term investments at year-end | $141.7 million | $46.3 million |
| Debt including finance leases at year-end | $136.1 million | $141.6 million |
| Current ratio | 2.2 | 1.9 |
Year-end net cash, based on cash and short-term investments less debt and finance leases, was $5.6 million. The company had $133.0 million drawn on its $200 million revolving credit facility, extended to November 2020, and reported compliance with its financial covenants. The board authorized a share repurchase program of up to $90 million over three years; 2015 dividends declared were $0.61 per share.
Material changes versus the prior comparable period
- Annual sales rose 5%, while gross margin improved 2.8 percentage points. Fuel Specialties sales increased 11% to $758.3 million; Performance Chemicals sales fell 13% to $194.5 million, partly reflecting the Aroma Chemicals divestiture and foreign exchange; Octane Additives sales rose 8% to $59.5 million.
- Fuel Specialties operating income was $103.9 million versus $104.4 million, with higher gross profit offset by increased operating costs, including costs from the Independence acquisition. Performance Chemicals operating income declined to $23.5 million from $25.6 million. Octane Additives operating income increased to $24.7 million from $22.6 million.
- Reported operating income included a $40.7 million gain from remeasurement of contingent consideration tied to the Independence acquisition, compared with a $1.9 million gain in 2014. It also included a $1.6 million profit on the Aroma Chemicals disposal. These unusual items materially affect the year-over-year comparison.
- Q4 2015 sales were $246.0 million versus $290.7 million in Q4 2014; operating income was $34.3 million versus $44.0 million, while net income was $31.5 million versus $27.9 million. Quarterly results include special items and should not be read as a direct measure of underlying trend.
- Operating cash flow increased $11.4 million year over year. Investing activities provided $15.0 million in 2015, including $41.5 million of proceeds from the Aroma Chemicals disposal; 2014 investing activities used $119.0 million, including acquisition spending.
Outlook, risks and contingencies
Management expected Fuel Specialties and Performance Chemicals to perform well in 2016. Lower crude-related raw material costs could benefit those businesses, but management cautioned that low oil prices could pressure oilfield-services customers and their spending. Management anticipated declining Octane Additives revenue; the company had no new contract with its sole remaining automotive TEL refinery customer and limited visibility beyond 2015, although it had received an inquiry for early-2016 supply. Innospec also expects AvTel sales to decline if an unleaded replacement for piston-engine aviation fuel is identified.
- The Independence contingent consideration liability was $54.6 million at year-end. The company paid $44.0 million in January 2016 and forecast a further $10.6 million payment approximately two years after closing, subject to acquisition terms and business performance.
- Environmental remediation provisions were $37.7 million, principally for the Ellesmere Port, UK site. The timing and ultimate cost depend on remediation scope and future circumstances; management noted no present intention to vacate the site.
- The UK defined-benefit pension plan is closed to future accrual. The company contributed $9.0 million in 2015 and expected contributions of $1.1 million in 2016. Pension obligations are sensitive to discount-rate, inflation and investment-return assumptions.
- Principal risks include oil and gas price volatility, lower customer exploration spending, reliance on the sole TEL customer, customer concentration, foreign exchange and raw-material cost changes, environmental obligations, regulatory and legal exposure, and execution and cost risks from the new information-system rollout.
- No material pending legal proceedings were reported. KPMG issued an unqualified opinion on the financial statements and internal control over financial reporting; management reported controls effective and said a previously identified material weakness in accounting for certain intercompany loans had been remediated.
Important facts for investors to verify
- How much of 2015 earnings growth reflects recurring operations versus the $40.7 million contingent-consideration gain and other unusual items.
- The outlook, contract status and remaining cash flows associated with Independence contingent consideration and the TEL customer.
- Oilfield-services trends, especially customer activity and spending in a low-price environment.
- The assumptions, timing and potential variability underlying the $37.7 million remediation provision and UK pension obligations.
- Progress and remaining costs or control risks for the company-wide information-system implementation.
- Liquidity and covenant headroom after the January 2016 contingent-consideration payment and any future share repurchases.