Innospec Inc. — Q3 2018 Form 10-Q
Business context and reporting period. Innospec manufactures specialty chemicals and reports four segments: Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives. This unaudited filing covers the three and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $363.1m | $332.4m | $1,081.9m | $953.0m |
| Gross profit | $111.0m | $98.8m | $318.3m | $294.8m |
| Operating income | $33.4m | $29.0m | $90.6m | $87.8m |
| Net income | $20.6m | $23.3m | $64.6m | $66.6m |
| Diluted EPS | $0.84 | $0.95 | $2.63 | $2.71 |
| Operating cash flow | Not separately stated for the quarter | $35.1m | $35.2m |
- Q3 gross margin was 30.6%, versus 29.7%; operating margin was approximately 9.2%, versus 8.7%. For the nine months, gross margin was 29.4%, versus 30.9%, and operating margin approximately 8.4%, versus 9.2%.
- Q3 income before taxes was $30.4m, compared with $29.9m. The effective tax rate rose to 32.2% from 22.1%; diluted EPS and net income consequently declined despite higher sales and operating income. Nine-month effective tax rate was 27.9%, versus 24.2%.
- Cash and cash equivalents were $91.4m at September 30, 2018, compared with $90.2m at year-end 2017. Current assets were $659.3m and current liabilities $290.5m. Adjusted working capital, a company-defined non-GAAP measure, was $307.8m, up from $245.4m.
- Debt was $223.9m, including $126.0m drawn on the revolving facility and a $99.0m term loan; finance lease obligations were $3.8m. Cash less reported debt implies approximate net debt of $132.5m, excluding leases.
- Nine-month investing cash outflow was $26.2m, including $20.0m of capital expenditures and $5.4m net cash paid for business combinations. Financing cash outflow was $7.4m, including $10.7m of dividends.
Changes versus comparable periods
- Q3 sales increased 9%; nine-month sales increased 14%. Operating income rose 15% in Q3 but only 3% for the nine months; net income declined 12% and 3%, respectively.
- Q3 segment sales increased 27% in Oilfield Services and 4% each in Fuel Specialties and Performance Chemicals; Octane Additives fell 9%. Nine-month increases were 30%, 9% and 15%, respectively, while Octane Additives declined 52%.
- Performance Chemicals benefited from higher volumes, product mix and manufacturing improvements. Oilfield Services growth reflected stronger customer activity, but margins were pressured by raw-material, transportation and labor costs. Fuel Specialties’ nine-month margin eased; Octane Additives’ gross profit contracted as production fell.
- Working capital increased: receivables rose $43.3m and inventories $52.1m from year-end, partly reflecting higher Oilfield Services activity and anticipated fourth-quarter sales. Operating cash flow was essentially unchanged year over year despite this working-capital investment.
Outlook, risks and unusual items
- The filing gives no quantified earnings, revenue or margin guidance. Management said inventory increases related to expected fourth-quarter sales across the segments. Octane Additives is expected to decline as its sole remaining refinery customer transitions to unleaded fuel.
- A $4.8m restructuring charge was recorded, primarily for the planned closure of the Belgium operation. In May, Innospec acquired BioSuite, an oil-and-gas biocide and biostat formulator, for stated consideration of $8.6m; a further performance-related payment was estimated at $3.2m, subject to BioSuite earnings.
- Foreign-exchange translation losses and a higher tax burden affected reported results. The company also reported a $1.6m nine-month loss on foreign-currency forwards. It continued to evaluate accounting for U.S. tax-reform provisions, including GILTI; the policy choice was not yet made.
- Environmental and plant-closure provisions totaled $48.9m, including $44.9m due after one year. The filing reports no material pending legal proceedings, but notes that a large number of adverse outcomes in individual claims could have a material aggregate effect. Guarantees not recognized as liabilities totaled $5.3m.
- Management expected the new lease standard to materially increase reported assets and liabilities, with no significant impact expected on income, equity or cash flows. Disclosure controls were deemed effective, with no material internal-control changes reported.
- After quarter-end, the board authorized a new share repurchase program of up to $100m over three years. No shares were repurchased under the prior program during the first nine months of 2018.
Most important facts for investors to verify
- Whether higher sales convert into improved operating and net income, given margin pressure and rising operating expenses.
- Receivables, inventory levels and cash conversion, especially as Oilfield Services activity and anticipated fourth-quarter demand affect working capital.
- Oilfield Services’ ability to recover raw-material, transportation and labor cost inflation; and continued decline in Octane Additives.
- The effective tax rate, completion of tax-reform accounting, and outcomes of Italian tax audits; the filing says the prior owner is contractually responsible for reimbursing specified audit liabilities.
- Execution and costs of the Belgium closure, BioSuite’s performance-linked consideration, environmental provisions and the new repurchase authorization.