Innospec Inc. — Q2 2014 Form 10-Q
Business context and period. Unaudited results cover the three and six months ended June 30, 2014, compared with the corresponding 2013 periods. Innospec operates Fuel Specialties, Performance Chemicals and Octane Additives. Management describes the first two as growth businesses; Octane Additives is declining as its sole remaining customer transitions to unleaded fuel. Amounts below are in millions of dollars except per-share data.
Key financial metrics
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Net sales | $221.3 | $185.0 | $442.0 | $384.4 |
| Gross profit | $68.6 | $59.4 | $134.3 | $123.2 |
| Gross margin | 31.0% | 32.1% | 30.4% | 32.0% |
| Operating income | $25.3 | $22.3 | $43.3 | $44.5 |
| Net income | $18.5 | $17.1 | $35.4 | $35.1 |
| Diluted EPS | $0.75 | $0.71 | $1.44 | $1.46 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $33.8 | $37.6 |
Q2 revenue rose 20% year over year, while first-half revenue rose 15%. Q2 operating income increased, but first-half operating income declined slightly. First-half cash from operations fell $3.8 million, with the company citing increased working-capital needs and tax movements. Capital expenditures were $6.0 million in the first half; investing cash outflow was $7.8 million and financing cash outflow was $14.9 million.
At June 30, cash and cash equivalents were $91.4 million and short-term investments were $6.0 million. Total debt was $139.5 million, comprising $134.0 million drawn on the revolving facility, a $5.0 million promissory note and $0.5 million of other debt. Cash plus short-term investments less debt implies net debt of approximately $42.1 million. Current assets were $405.9 million and current liabilities $125.5 million. Adjusted working capital, a company-defined non-GAAP measure, was $179.8 million, up $16.1 million from year-end 2013.
Total assets were $786.8 million, total liabilities $345.5 million and stockholders’ equity $441.3 million. Pension liabilities were $33.0 million; plant-closure provisions totaled $31.6 million, of which $4.8 million was current. The first-half GAAP effective tax rate was 17.3%, versus 19.9%; management’s adjusted rate was 22.4%, versus 20.8%.
Material changes and segment performance
- Fuel Specialties: Q2 sales increased 15% to $145.1 million, but operating income declined to $17.5 million from $19.2 million and gross margin fell to 30.3% from 32.1%. First-half sales rose 16% to $309.3 million while operating income edged down to $43.3 million. Bachman acquisition sales contributed to growth; higher Bachman costs and lower sales of higher-margin products weighed on results. Management cited weaker EMEA trading and Russia-related sanctions, lower ASPAC sales following a lost contract, and stronger Americas demand.
- Performance Chemicals: Q2 sales rose 33% to $59.4 million and operating income rose to $7.8 million from $6.5 million. First-half sales increased 25% to $115.5 million and operating income to $14.3 million from $11.5 million. Acquisitions, including Chemsil and Chemtec, and Personal Care sales supported growth; acquisition-related costs also increased expenses.
- Octane Additives: Q2 sales rose 17% to $16.8 million, mainly due to shipment timing; first-half sales fell 34% to $17.2 million amid shipment timing and declining demand from the sole remaining customer. The company says the segment continues to decline as that customer transitions away from leaded fuel.
In Q2, higher operating expenses—including acquisition costs—offset some gross-profit growth. First-half amortization increased to $8.8 million from $4.2 million, including costs associated with acquired intangibles and the new information-system platform. The company reported no goodwill impairment in 2014, compared with $0.6 million in the first half of 2013. The first-half 2013-to-2014 comparison also includes acquisition contributions following the 2013 Bachman acquisition.
Outlook, risks and unusual items
- The filing provides no quantified earnings or sales guidance. Management said higher inventories were being built ahead of expected sales increases in the third and fourth quarters; this is not a formal forecast.
- On July 31, 2014, after quarter-end, the company increased revolving-credit borrowing capacity by $20 million to $200 million. The facility expires December 14, 2016.
- A UK claim by JAG seeks up to $42.3 million, inclusive of costs and expenses, for alleged lost profits relating to business in Iraq. The trial concluded June 26, 2014; the company disputed the allegations and expected a judgment around October 2014. The filing does not state an outcome or a clearly quantified accrual for the claim.
- Environmental remediation provisions were $31.6 million, principally related to the Ellesmere Port site. Management notes uncertainty about the timing and costs of any eventual site vacation and remediation program.
- Unrecognized tax benefits, interest and penalties totaled $9.0 million at June 30. The IRS examination for 2009 was effectively settled in March 2014 with nominal additional tax cost, reducing the related uncertain-tax balance by $4.0 million. The company intends to permanently reinvest overseas earnings; repatriation could create additional tax, which the filing says cannot currently be practicably calculated.
- The company reported a $0.7 million first-half loss on foreign-currency forward contracts, partly offset by currency translation gains. It also reported $7.6 million of contingent guarantees not recognized as liabilities. Management said there had been no material changes to the risk factors disclosed in its 2013 Form 10-K.
- Management concluded disclosure controls were effective as of June 30, 2014, and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the anticipated third- and fourth-quarter sales increase materialized, and whether higher inventory converted to sales and cash.
- The final result and financial impact, if any, of the JAG litigation and the adequacy of any related contingency disclosure or accrual.
- Segment-level organic growth and margins excluding acquisition contributions and acquisition-related expenses, particularly in Fuel Specialties and Performance Chemicals.
- Debt repayment, facility availability and interest costs, along with the effect of the July 31 facility-capacity increase.
- The scope, timing and cost assumptions underlying Ellesmere Port remediation provisions, and potential exposure from tax audits, guarantees and overseas earnings repatriation.