Innospec Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. This is an annual filing; quarterly figures below include fourth-quarter results. Amounts are in U.S. dollars.
Business context and reporting period
Innospec develops and supplies specialty chemicals through four segments: Fuel Specialties, Performance Chemicals, Oilfield Services, and Octane Additives. The company completed integration of the European Differentiated Surfactants business acquired from Huntsman in late 2016. Management’s strategy emphasizes product development and growth in the first three segments; Octane Additives is in structural decline as its remaining automotive gasoline customer transitions to unleaded fuel.
Financial performance and position
| Metric | FY2017 | FY2016 |
|---|---|---|
| Net sales | $1,306.8 million | $883.4 million |
| Gross profit / margin | $403.3 million / 30.9% | $332.3 million / 37.6% |
| Operating income | $129.7 million | $105.4 million |
| Income before taxes | $128.1 million | $103.1 million |
| Income tax expense / effective rate | $66.3 million / 51.8% | $21.8 million / 21.1% |
| Net income / diluted EPS | $61.8 million / $2.52 | $81.3 million / $3.33 |
| Operating cash flow | $82.7 million | $105.5 million |
| Cash and cash equivalents at year-end | $90.2 million | $101.9 million |
| Total debt, including finance leases | $224.3 million | $273.3 million |
| Current ratio | 2.1 | 2.4 |
Net debt was $134.1 million at year-end. Adjusted working capital increased to $245.4 million from $179.4 million, with acquisition-related funding needs and higher receivables and inventory contributing. Operating cash flow included an estimated $28.0 million one-off working-capital funding requirement related to Huntsman. Capital expenditures were $23.3 million. The annual dividend declared was $0.77 per share, up from $0.67.
Fourth-quarter 2017 sales were $353.8 million, gross profit $108.5 million, and operating income $38.4 million. The quarter recorded a net loss of $4.8 million, or $0.20 per diluted share, versus net income of $22.1 million, or $0.90 per diluted share, in fourth-quarter 2016. Fourth-quarter operating cash flow was $78.3 million.
Material changes versus the prior comparable period
- Sales rose 48%, substantially reflecting the Huntsman acquisition and a 59% increase in Oilfield Services sales as customer activity recovered. Performance Chemicals sales increased to $419.5 million from $138.7 million, largely due to the acquisition; Oilfield Services sales grew to $304.4 million from $191.7 million.
- Gross profit increased 21%, but consolidated gross margin fell 6.7 percentage points, mainly because the acquired Huntsman business carried lower margins. Performance Chemicals margin fell to 18.1% from 31.3%; Oilfield Services margin fell to 35.9% from 39.9%, partly due to Hurricane Harvey-related raw-material cost and availability effects.
- Operating income improved despite higher operating expenses. Segment operating income was $107.1 million in Fuel Specialties, $32.6 million in Performance Chemicals, $9.5 million in Oilfield Services (versus a $4.7 million loss), and $26.7 million in Octane Additives.
- Net income declined despite higher operating income, principally because the Tax Cuts and Jobs Act generated a provisional $47.7 million transition-tax expense. The company also recorded a $7.1 million deferred-tax benefit from remeasuring U.S. deferred tax balances. Management reported an adjusted effective tax rate of 20.2%, a non-GAAP measure.
- Interest expense rose to $8.2 million from $3.2 million, reflecting acquisition-related borrowing, working-capital funding, and higher LIBOR. Operating cash flow decreased by $22.8 million year over year.
Outlook, risks, contingencies, and unusual items
- Management expects Fuel Specialties, Performance Chemicals, and Oilfield Services to perform well in 2018, but gave no numerical earnings or revenue guidance. It anticipates declining Octane Additives revenue and has limited visibility because no new contract has been agreed with the segment’s sole remaining automotive refinery customer.
- Year-end borrowings comprised $121.0 million drawn on a $200 million revolving facility and a $99.0 million term loan; finance leases were $5.9 million. The facility matures in 2020 and includes quarterly covenants of net debt/EBITDA no greater than 3.0:1 and EBITDA/net interest no less than 4.0:1. Management reported compliance and did not expect a breach in the next 12 months. Most debt bears floating rates, partly hedged by $149 million notional interest-rate swaps.
- Environmental remediation and plant-closure provisions were $46.1 million, principally related to the Ellesmere Port, U.K. site; $5.2 million was expected to be paid within one year. The company says site-vacating costs are contingent because it has no present intention to vacate. No material legal proceedings were pending.
- Key risks include volatility in oil and gas activity, customer concentration (particularly TEL), raw-material and energy costs, supply disruption, foreign-exchange exposure, regulatory and environmental obligations, pension assumptions, cybersecurity, and acquisition integration. Germany ethylene supply is effectively single-source; related products represent about 4% of sales.
- The Tax Reform Act accounting was provisional, including transition-tax and other calculations; the company had not yet selected an accounting policy for GILTI. It intended to pay the $47.7 million transition tax over the statutory eight-year schedule. The U.K. defined-benefit pension plan is closed to future accrual; its reported pension asset was $116.0 million, and management noted material sensitivity to discount-rate and inflation assumptions.
- Auditor KPMG issued an unqualified opinion on the financial statements and internal control over financial reporting. Management also concluded disclosure controls and internal controls were effective at year-end.
Important facts for investors to verify
- How much of revenue and operating income growth reflects organic performance versus Huntsman acquisition contribution, and whether acquired Performance Chemicals margins improve.
- Whether Oilfield Services demand and margins can sustain the 2017 recovery, including the effects of commodity prices and raw-material availability.
- Progress and timing of the remaining TEL customer’s transition, contract status, and the resulting revenue, cash-flow, and remediation implications.
- Final tax accounting under the Tax Reform Act, including the transition-tax estimate, GILTI treatment, and cash-payment schedule.
- Working-capital conversion, debt repayment and covenant headroom, and the company’s ability to fund operations and shareholder returns from cash generation.
- Assumptions supporting the $46.1 million remediation provision and the U.K. pension valuation, including sensitivity to future costs, discount rates, and inflation.