INNOSPEC INC. quarterly report, Q3 FY2012

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Business context and reporting period

Innospec Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2012. Its businesses are Fuel Specialties, Performance Chemicals (renamed from Active Chemicals effective October 1, 2012), and Octane Additives. Octane Additives operates in a market management describes as volatile and declining.

Financial results and liquidity

  • Third quarter: Revenue was $183.4 million, down 9% from $202.1 million. Gross profit was $50.7 million (27.6% margin), versus $57.7 million (28.6%). Operating income was $17.3 million, compared with an operating loss of $20.2 million; net income was $15.5 million, or $0.65 diluted per share, versus a net loss of $16.8 million, or $0.71 per share.
  • Nine months: Revenue was $562.7 million, down 2% from $573.9 million. Gross profit increased to $171.4 million from $168.6 million, and gross margin rose to 30.5% from 29.4%. Operating income was $72.6 million, versus $26.1 million; net income was $55.6 million, or $2.33 diluted per share, versus $29.3 million, or $1.19 per share.
  • Cash flow: Nine-month operating cash flow was $64.0 million, compared with $20.9 million. Investing activities used $11.0 million, including $5.7 million of capital expenditures and $6.4 million capitalized for software and other costs. Cash increased $53.4 million to $129.6 million.
  • Balance sheet: Cash and short-term investments totaled $133.6 million. Debt was $34.0 million ($24.0 million revolving credit and $10.0 million promissory note), giving net cash of approximately $99.6 million on that basis. Current assets were $375.1 million and current liabilities $152.1 million; stockholders’ equity was $403.0 million.

Material changes versus prior comparable periods

  • Third-quarter sales fell most sharply in Octane Additives (down 57%, to $9.6 million), reflecting lower volumes and reduced environmental-remediation revenue. Fuel Specialties sales declined 7%; Performance Chemicals sales rose 7%.
  • For the nine months, Fuel Specialties operating income increased to $58.2 million from $54.5 million. Performance Chemicals operating income declined to $18.8 million from $21.7 million; Octane Additives generated $21.9 million versus a loss of $27.8 million.
  • The reported comparison is materially affected by a $45.0 million NewMarket Corporation civil complaint settlement recorded in 2011. Excluding that prior-year item, the dramatic year-over-year improvement in operating results is less pronounced. Corporate costs rose to $25.5 million for nine months from $20.3 million, partly due to higher share-based compensation accruals.
  • Other net expense for nine months was $3.3 million, versus $8.9 million of other net income in 2011, largely reflecting foreign-currency translation effects. The nine-month effective tax rate was 18.8%, versus 10.1%; management’s adjusted rates were 19.0% and 20.4%, respectively.

Outlook, management commentary, risks and unusual items

  • The filing provides no explicit sales or earnings guidance. Management expects 2012 cash contributions to the UK defined-benefit pension plan of approximately $9 million; $7.0 million had been contributed in the first nine months.
  • On October 5, 2012, Innospec submitted a preliminary, non-binding proposal to acquire TPC Group for $44–$46 per share in cash. The proposal was subject to due diligence, approvals and definitive documentation; contemplated funding included debt and a preferred-equity investment affiliated with Blackstone.
  • The company’s $40.2 million government-investigation settlement is payable over four years beginning in 2010. At September 30, $13.8 million remained recorded, of which $9.7 million was due within one year. Other guarantees totaled $7.3 million. The company reported no other material pending legal proceedings, while noting aggregate exposure from individual claims could be adverse.
  • Environmental remediation provisions totaled $28.5 million, including $27.4 million for remediation at Ellesmere Port. Management stated that costs of eventually vacating the site were contingent and that uncertainty about TEL’s product life made some future cash flows too uncertain to estimate reliably for recognition.
  • Most cash was held outside the U.S. ($127.7 million); management said it did not expect to repatriate foreign earnings in the foreseeable future. Commodity hedges were deemed ineffective from March 2012, with subsequent fair-value changes recognized in earnings. Management reported effective disclosure controls and no material change in internal control over financial reporting.

Important facts for investors to verify

  1. How much of the earnings improvement reflects ongoing operations versus the $45.0 million settlement in the 2011 comparison, and how segment volumes and margins are trending.
  2. Whether the proposed TPC Group acquisition proceeded, its final financing terms, and potential effects on debt, liquidity and shareholder dilution.
  3. The timing and eventual cost of Ellesmere Port remediation and closure, given the acknowledged uncertainty around TEL demand and site-exit costs.
  4. Cash availability and any constraints or tax consequences associated with the substantial balance held by non-U.S. subsidiaries.
  5. Potential exposure from the $12.5 million of unrecognized tax benefits, pension funding obligations, settlement payments and guarantees.