INNOSPEC INC. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Innospec reports three segments: Fuel Specialties, Performance Chemicals and Octane Additives. Results are unaudited and in U.S. dollars; amounts below are in millions except per-share data.
Financial results
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $220.7 | $199.4 |
| Gross profit / margin | $65.7 / 29.8% | $63.8 / 32.0% |
| Operating income | $18.0 | $22.2 |
| Net income | $16.9 | $18.0 |
| Diluted EPS | $0.69 | $0.75 |
| Operating cash flow | $20.9 | $17.9 |
- Revenue rose 11%, while operating income declined 19% and net income declined 6%. Higher selling, general and administrative expense and the sharp contraction in Octane Additives outweighed growth in the other segments.
- Segment sales and operating income: Fuel Specialties $164.2 and $25.8, versus $140.0 and $24.9; Performance Chemicals $56.1 and $6.5, versus $47.8 and $5.0; Octane Additives $0.4 and a $1.2 operating loss, versus $11.6 and $4.8 income.
- Cash and cash equivalents were $90.1 at March 31, up from $80.2 at year-end; short-term investments were $5.8. Total debt was $139.7, down from $148.0, including $134.0 drawn on the revolving facility. The facility provides up to $180.0 through December 2016, with a possible additional $20.0 commitment.
- Current assets were $394.6 and current liabilities $127.0. Adjusted working capital, a company-defined non-GAAP measure, was $170.9 versus $163.7 at year-end. Capital expenditures were $2.4; cash paid into defined-benefit pension plans was $2.9.
- Income tax expense was $2.1 and the reported effective tax rate 11.1%, versus $4.9 and 21.4%. The adjusted effective tax rate was 22.6% versus 23.1%; the lower reported rate reflected a $4.0 reduction in uncertain tax benefits and related interest and penalties after settlement of the 2009 IRS examination.
Material changes and management commentary
- Fuel Specialties sales increased 17%, supported by demand and the Bachman acquisition. Its gross margin decreased to 31.7% from 33.6%, primarily due to lower Avtel sales and adverse ASPAC mix.
- Performance Chemicals sales increased 17% and gross margin improved to 24.2% from 22.0%, reflecting improved mix in Personal Care and higher Chemsil margins, partly offset by adverse ASPAC mix. Acquisitions also contributed to sales growth.
- Octane Additives sales fell 97%, principally from sharply lower volumes and declining demand from major customers, as well as shipment timing and lower remediation revenue. Management described the segment’s demand as volatile and declining.
- Aggregate gross margin fell 2.2 percentage points. Operating expenses increased $6.1 to $47.7; reported corporate costs included higher information-system amortization, an insurance-claims provision and legal and professional costs, partly offset by lower compensation accruals.
- The company generated $20.9 of operating cash flow despite lower net income and higher working-capital requirements. It repaid $8.0 on the revolving facility during the quarter.
Outlook, risks and unusual items
- The filing provides no specific numerical sales or earnings guidance. Management said the lower Avtel sales reflected shipment timing rather than a change in its long-term market outlook. The company cautioned that interim results are not necessarily indicative of full-year results.
- Innospec acquired Bachman in November 2013 for $45.8 cash and 319,953 shares valued at approximately $15.0. The preliminary allocation included $25.9 of intangibles and $22.9 of goodwill; valuation was not final, with completion expected in Q2 2014.
- A U.K. High Court claim by JAG seeks up to $42.3, inclusive of costs and expenses, over alleged lost profits relating to Iraq business in 2004–2010. Innospec disputes the allegations and intends to defend the claim.
- Plant-closure provisions totaled $32.7, including $31.7 for remediation, principally at Ellesmere Port. Estimates depend on future work, environmental requirements and uncertain timing; the company said it has no present intention to vacate the site.
- Cash held by non-U.S. subsidiaries was $84.1. The company intends to reinvest foreign earnings overseas and has not provided for potential additional U.S. tax on repatriation. It reported $605 of unremitted overseas earnings at December 31, 2013.
- Other risks include floating-rate debt, foreign-exchange exposure, uncertain tax positions, pension obligations and the risks described in the 2013 Form 10-K. Management reported no material change in risk factors or market-risk exposure. Disclosure controls were deemed effective at March 31, 2014.
Important facts for investors to verify
- Whether growth in Fuel Specialties and Performance Chemicals, including acquired sales, is sustained and supports margins after acquisition costs.
- How Octane Additives’ declining demand and shipment timing affect future segment results.
- Final Bachman purchase-price allocation and its effect on amortization, goodwill and reported earnings.
- Developments in the JAG litigation and the range of possible financial exposure; the filing does not state a clear estimate of likely loss.
- Remediation-cost assumptions at Ellesmere Port, future pension funding needs and potential tax consequences if overseas earnings are repatriated.