Innospec Inc. — 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. The filing also reports unaudited fourth-quarter results. Innospec develops and sells fuel additives, personal care and fragrance products, and other specialty chemicals through Fuel Specialties, Active Chemicals, and Octane Additives.
Financial performance
| Metric | 2011 | 2010 |
|---|---|---|
| Net sales | $774.4 million | $683.2 million |
| Gross profit / gross margin | $226.4 million / 29.2% | $214.1 million / 31.3% |
| Operating income | $49.6 million | $72.2 million |
| Net income | $48.9 million | $73.7 million |
| Diluted EPS | $1.99 | $2.97 |
| Operating cash flow | $34.7 million | $58.2 million |
| Cash and short-term investments at year-end | $81.0 million | $111.3 million |
| Total debt at year-end | $35.0 million | $47.0 million |
| Current ratio | 2.2 | 2.0 |
Sales rose 13%, led by Fuel Specialties (+14%) and Active Chemicals (+16%); Octane Additives sales increased 5%. Gross profit increased 6%, but consolidated gross margin fell 2.1 percentage points. Fuel Specialties margin declined to 28.6%, principally due to sales mix and raw-material cost pressure; Active Chemicals margin improved to 22.9%.
Fourth quarter 2011: Sales were $200.5 million, gross profit $57.8 million, operating income $23.5 million, net income $19.6 million, and operating cash flow $13.8 million. The third quarter included a $16.8 million net loss, largely reflecting the civil settlement described below.
Material changes and unusual items
- Operating income fell 31% and net income fell 34%, despite sales growth. A $45.0 million expense for settlement of the NewMarket Corporation civil complaint was recognized in 2011. The settlement was paid through $25.0 million cash, a $15.0 million promissory note, and approximately $5.0 million in company shares.
- Octane Additives reported a $22.4 million operating loss versus $25.8 million operating income in 2010, primarily reflecting the NewMarket settlement. Excluding that settlement, segment operating expenses increased year over year, including higher legal and professional costs.
- Fuel Specialties operating income was $81.7 million versus $77.6 million; Active Chemicals operating income was $22.6 million versus $16.7 million. Octane Additives recorded $2.0 million of non-cash goodwill impairment; $2.6 million of segment goodwill remained at year-end.
- Other net income was $6.3 million, including $6.5 million of foreign-exchange gains. The reported effective tax rate was 7.0%; management cited an adjusted rate of 15.8% after specified settlement and tax-provision adjustments.
Cash, debt, and liquidity
Year-end cash and short-term investments totaled $81.0 million against $35.0 million of debt, or net cash of $46.0 million. The company generated $34.7 million of operating cash flow, spent $10.1 million on capital expenditures and software capitalization, and used $55.0 million in financing activities. Financing cash use included $28.1 million of share repurchases. Adjusted working capital increased $30.0 million to $109.0 million, including higher receivables and inventories.
In December 2011, Innospec entered a five-year revolving credit facility of up to $100 million, expiring December 14, 2016; $20 million was drawn at year-end. The facility has quarterly covenants: net debt to EBITDA no greater than 2.5:1 and EBITDA to net interest no less than 4.0:1. Management reported compliance and expected continued compliance for the next 12 months. The company said it expected to fund operations over at least that period from operating cash flows and the facility.
Outlook, risks, and contingencies
- Management expected to cease all sales of TEL for automotive gasoline in 2013. Octane Additives demand is declining, with remaining sales concentrated among relatively few customers; faster-than-expected declines could accelerate goodwill impairment and reduce cash flows.
- Committed obligations included $51.8 million of planned UK pension contributions, $27.1 million of environmental remediation payments, and $11.7 million of remaining OFFP/FCPA fines, penalties, and disgorgements, plus compliance-monitor costs. The filing estimates approximately $5 million of REACH compliance costs over six years.
- The UK defined-benefit plan was closed to future service accrual. At year-end, plan assets exceeded the projected benefit obligation by $21.4 million, compared with an $11.7 million deficit in 2010. Funding needs and pension expense remain sensitive to investment returns, discount rates, inflation, and mortality assumptions.
- Key business risks include raw-material availability and price volatility, ability to pass cost increases through to customers, customer concentration (Shell represented 10% of 2011 sales), foreign exchange, regulation and environmental liabilities, legal and tax exposures, and manufacturing or supply disruptions.
- There were no other material pending legal proceedings reported. Management and the independent auditor concluded internal control over financial reporting was effective as of December 31, 2011. The filing gives no specific numerical sales or earnings guidance.
Most important facts for investors to verify
- How much of the 2011 earnings decline is attributable to the $45 million NewMarket settlement, and what recurring profitability looks like by segment.
- Whether Fuel Specialties can restore margins amid raw-material cost and product-mix pressures, and whether Active Chemicals growth and margin gains continue.
- The pace of TEL volume decline through the stated 2013 endpoint, customer concentration, and any resulting impairment or remediation consequences.
- Cash conversion and working-capital requirements, especially the increase in receivables and inventories, alongside share repurchases and debt repayments.
- Progress against pension-funding and environmental-remediation obligations, and continued compliance with credit-facility covenants.