Innospec Inc. — Q2 2011 Form 10-Q
Business context and period. Unaudited results for the three and six months ended June 30, 2011, compared with the same 2010 periods. Innospec reports Fuel Specialties, Active Chemicals and Octane Additives; the last operates in a structurally declining tetra ethyl lead market. Amounts are in U.S. dollars; financial figures below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Net sales | $186.5 | $168.4 | $371.8 | $331.9 |
| Gross profit / margin | $58.1 / 31.2% | $54.0 / 32.1% | $110.9 / 29.8% | $105.4 / 31.8% |
| Operating income / margin | $22.4 / 12.0% | $24.8 / 14.7% | $46.3 / 12.4% | $36.1 / 10.9% |
| Income before taxes | $29.5 | $12.9 | $57.8 | $22.9 |
| Net income | $24.6 | $12.0 | $46.1 | $19.4 |
| Diluted EPS | $1.00 | $0.48 | $1.88 | $0.78 |
| Operating cash flow | Not stated for quarter | $11.5 | $20.4 |
- Q2 sales increased 11%; first-half sales increased 12%. Active Chemicals led growth, while Octane Additives sales declined.
- Q2 SG&A was $30.5 versus $24.1; first-half SG&A was $54.5 versus $51.4. Q2 operating income fell despite higher sales, while first-half operating income rose, helped by lower pension and restructuring charges.
- Other net income was $7.9 in Q2 and $13.2 for the first half, versus losses of $10.8 and $10.9, respectively, in 2010. Management attributed the 2011 gains principally to foreign-currency translation and, for the first half, foreign-exchange contracts. This materially supported the increase in pretax and net income.
- Effective tax rates were 16.6% in Q2 and 20.2% for the first half, compared with 7.0% and 15.3% in 2010. Management cited the prior-year U.K. tax-position settlement adjustment and geographic mix; the U.K. corporation tax rate also fell from 28% to 27%.
Segments
- Fuel Specialties: Q2 sales rose 9% to $113.3, but gross margin fell to 27.4% from 30.8% and operating income was $12.3 versus $17.1. First-half sales rose 11% to $240.4, while gross margin declined to 28.1% from 32.2%. Management cited competitive pressure and rising raw-material costs.
- Active Chemicals: Q2 sales rose 28% to $48.7 and gross margin increased to 28.1% from 21.3%; operating income was $9.1 versus $3.6. First-half sales rose 26% to $95.2 and gross margin improved to 26.7% from 21.3%, with margin improvement particularly in Polymers.
- Octane Additives: Q2 sales fell 6% to $24.5 and operating income fell to $8.1 from $11.6. First-half sales declined 8% to $36.2 and operating income was $10.3 versus $18.3. Shipment timing and mix affected sales; segment demand has declined about 10% annually on average over the prior five years.
Liquidity, debt and financial position
- At June 30, cash and cash equivalents were $99.0, short-term investments $4.4 and total debt $33.0, all classified as current. Cash exceeded debt by $66.0; including short-term investments, net cash was $70.4. The credit facility expires February 6, 2012, when a $25.0 term-loan repayment is due.
- Cash declined $8.1 from year-end 2010. First-half operating cash flow was $11.5, down from $20.4; investing used $4.1 and financing used $16.2. Working-capital use included $11.6 from receivables and $19.2 from inventories.
- Working capital was $170.5 versus $163.0 at year-end; company-defined adjusted working capital increased to $109.1 from $79.0, reflecting higher receivables and inventories.
- Total assets were $572.1 and stockholders’ equity $340.8. The pension liability was $7.8, down from $11.7 at year-end. The company expects 2011 cash contributions to its U.K. defined-benefit plan of approximately $9 million, compared with $15.5 million in 2010.
- Management reported compliance with debt covenants at June 30 and expected continued compliance through the facility’s remaining term. Covenants include net debt/EBITDA no greater than 2.5:1 and EBITDA/net interest at least 4.0:1; the facility is secured and includes restrictive provisions.
Outlook, risks and unusual items
- The filing provides no clear company-wide sales or earnings forecast. Management’s stated outlook includes expected 2011 pension contributions of approximately $9 million and an expectation of continued debt-covenant compliance.
- Goodwill impairment for Octane Additives was $0.5 in Q2 and $1.1 for the first half. The company expects further impairment charges approximately on a straight-line basis through December 31, 2012 as TEL-related cash flows decline.
- A previously reached $40.2 settlement concerning legacy Oil for Food, FCPA, Cuban sanctions and U.K. anti-bribery matters is payable over four years from 2010. At June 30, the filing showed $13.5 remaining, including $11.0 due within one year.
- NewMarket/Afton’s civil antitrust and business-conspiracy complaint seeks unspecified treble damages, fees and costs. Innospec says it will defend the case, but cannot reasonably estimate potential damages; it had a $2.0 provision for probable future legal expenses and no additional accrual for the claim.
- Plant-closure provisions totaled $27.4, including $26.1 for remediation; $4.0 was classified as due within one year. The company says costs of eventually vacating its Ellesmere Port site are contingent and that uncertain TEL product life prevents reliable estimation of certain future cash flows.
- During Q2, the company reclassified certain intangible amortization between cost of goods sold and SG&A for 2011 and comparative periods. It stated this had no effect on sales, pretax income, net income, EPS, operating cash flow or balance-sheet categories.
- Management identified contingencies, environmental liabilities, goodwill, intangible assets, pensions, deferred-tax valuation allowances and uncertain tax positions as critical accounting estimates. The filing warns that forward-looking statements are subject to risks and uncertainty; risk factors were reported as having no material change from the 2010 Form 10-K.
Most important facts for investors to verify
- How much of reported earnings growth reflects recurring operations versus foreign-exchange gains and tax effects.
- Whether Fuel Specialties can restore margins amid raw-material inflation and competitive pressure, and whether Active Chemicals’ margin gains persist.
- Cash conversion and working-capital trends, particularly the rise in receivables and inventories as operating cash flow weakened.
- Debt refinancing or repayment arrangements before the February 2012 facility maturity, including covenant headroom.
- Developments in the NewMarket litigation, remaining settlement payments and environmental remediation obligations.
- The pace of TEL market decline and resulting Octane Additives cash flows and goodwill impairment.