Innospec Inc. — Q3 2014 Form 10-Q
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2014, compared with the same 2013 periods. Innospec reports Fuel Specialties, Performance Chemicals and Octane Additives. Fuel Specialties and Performance Chemicals are growth businesses; Octane Additives is declining as its remaining customer transitions to unleaded fuel. Amounts below are in millions of U.S. dollars unless stated otherwise.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $228.2 | $192.8 | $670.2 | $577.2 |
| Gross profit | $73.6 | $57.4 | $207.9 | $180.6 |
| Operating income | $25.2 | $19.5 | $68.5 | $64.0 |
| Net income | $20.8 | $14.0 | $56.2 | $49.1 |
| Diluted EPS | $0.83 | $0.58 | $2.26 | $2.04 |
- Q3 sales increased 18%, gross profit 28%, operating income 29%, and net income 49% year over year. Q3 aggregate gross margin was 32.3%, up 2.5 percentage points; operating margin was approximately 11.0%, versus 10.1%.
- For the first nine months, sales rose 16%, gross profit 15%, operating income 7%, and net income 14%. Aggregate gross margin was 31.0%, down 0.3 percentage points; operating margin was approximately 10.2%, versus 11.1%.
- Q3 segment sales were Fuel Specialties $156.1 million (+14%), Performance Chemicals $57.0 million (+19%), and Octane Additives $15.1 million (+101%). The Octane increase mainly reflected shipment timing with its remaining customer.
- Nine-month segment sales were Fuel Specialties $465.4 million (+15%), Performance Chemicals $172.5 million (+23%), and Octane Additives $32.3 million (-3%). Acquisition contributions were significant to growth in Fuel Specialties and Performance Chemicals.
- Q3 GAAP effective tax rate was 18.1%, versus 23.5%; the company’s adjusted, non-GAAP rate was 25.2%, versus 23.0%. Nine-month rates were 17.6% and 23.5% GAAP, and 23.5% and 21.4% adjusted, respectively.
Cash flow, balance sheet and debt
- Operating cash flow for the first nine months was $59.0 million, compared with $31.8 million in 2013. Investing used $13.5 million, including $9.5 million of capital expenditures; financing used $34.4 million, including $6.6 million of dividends and $27.0 million net repayments under the revolving facility.
- Cash and cash equivalents were $90.4 million at September 30, 2014, versus $80.2 million at December 31, 2013; short-term investments were $4.9 million. The company said $84.2 million of cash was held by non-U.S. subsidiaries and it did not expect to repatriate foreign earnings in the foreseeable future.
- Debt was $115.0 million, down from $148.0 million at year-end 2013. The revolving credit facility’s borrowing capacity was increased by $20 million to $200 million, expiring December 14, 2016. Current assets were $397.6 million and current liabilities $121.4 million; adjusted working capital, a company-defined non-GAAP measure, was $175.9 million, up from $163.7 million.
- Inventory increased $13.0 million from year-end, partly to prepare for seasonal demand, while accounts payable and accrued liabilities decreased $19.7 million. Management noted working capital normally rises during the first nine months ahead of fourth-quarter peak sales.
Material changes, outlook and risks
- Q3 Fuel Specialties sales benefited from the Bachman acquisition and improved price/product mix, but lower volumes in EMEA reflected weaker trading and Russia-related sanctions. Performance Chemicals benefited from stronger Personal Care mix and acquisitions Chemsil and Chemtec. Octane Additives remains exposed to declining customer demand and environmental remediation activity.
- Operating expenses rose 29% in Q3, with higher acquisition-related costs and a $1.8 million increase in bad-debt provisions among the drivers. Nine-month amortization increased to $12.7 million from $6.6 million, including amortization associated with acquired intangibles and the new information-system platform.
- On October 27, 2014, after quarter-end, Innospec acquired Independence Oilfield Chemicals for discounted consideration of $212.8 million. The initial $99.0 million payment was funded with cash and debt facilities; two deferred payments are due over approximately the following two years. Debt outstanding under the facility was $154.0 million at October 31. The purchase-price allocation was preliminary, and pro forma information was not available in the filing.
- The company provided no specific earnings or revenue guidance in the supplied filing text. It said existing cash and debt facilities were expected to provide adequate liquidity for working-capital needs. Management’s forward-looking statements remain subject to risks and uncertainties; it reported no material change in risk factors from its 2013 Form 10-K.
- Environmental remediation provisions totaled $31.5 million, including $27.4 million classified as non-current. Estimates involve uncertainty, particularly for the Ellesmere Port site, and costs are recognized as obligations become probable and estimable. Guarantees not recorded as liabilities totaled $6.4 million.
- A UK claim seeking up to $42.3 million was dismissed in its entirety on October 8, 2014; Innospec may seek reimbursement of legal expenses. The 2009 U.S. federal tax examination was effectively settled in March 2014 at nominal additional tax cost. Unrecognized tax benefits and related interest and penalties totaled $5.9 million at September 30.
- Quarterly and nine-month comprehensive income were affected by foreign currency translation losses of $6.0 million and $6.2 million, respectively. The filing also identifies foreign-exchange exposure, floating-rate debt, pension obligations and uncertain environmental costs as relevant risks.
Important facts for investors to verify
- Independence acquisition integration, final purchase-price allocation, deferred-payment terms and resulting leverage and liquidity.
- Whether acquisition-led growth translates into sustained organic volume and profit growth, particularly in Fuel Specialties and Performance Chemicals.
- Inventory build, receivables collections, bad-debt provisions and cash conversion as the company enters its seasonal fourth-quarter period.
- Durability of gross-margin gains against higher operating expenses, acquired-business costs and elevated amortization.
- Progress and eventual cost of environmental remediation, pension funding, and resolution of remaining tax uncertainties.
- How the expected transition away from leaded fuel affects the remaining Octane Additives business and associated site obligations.