Innospec Inc. — Q3 2017 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2017. Innospec reports four segments: Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives. Comparisons are substantially affected by the December 2016 acquisition of Huntsman’s European Differentiated Surfactants business, included in Performance Chemicals.
Key financial metrics
| Metric | Three months 2017 | Three months 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $332.4 million | $205.5 million | $953.0 million | $645.6 million |
| Gross profit | $98.8 million | $79.2 million | $294.8 million | $240.9 million |
| Gross margin | 29.7% | 38.5% | 30.9% | 37.3% |
| Operating income | $30.2 million | $18.9 million | $91.3 million | $73.1 million |
| Net income | $23.3 million | $11.4 million | $66.6 million | $59.2 million |
| Diluted earnings per share | $0.95 | $0.47 | $2.71 | $2.42 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $35.2 million | $87.0 million |
At September 30, 2017, cash was $65.5 million, total current assets were $532.7 million and current liabilities were $237.9 million. Total debt, net of deferred financing costs, was $229.3 million; finance lease obligations were $5.8 million. Stockholders’ equity was $747.5 million. Nine-month capital expenditures were $16.4 million and dividends paid were $9.2 million.
Material changes and segment performance
- Third-quarter sales increased 62% year over year, while gross profit rose 25%. Nine-month sales increased 48%, gross profit 22%, and net income 13%. Acquisition-related sales growth, particularly in Performance Chemicals, is a major factor in the revenue increase.
- Performance Chemicals sales rose 200% in Q3 and 190% for the nine months, primarily reflecting Huntsman. Its gross margin fell 14.6 percentage points in Q3 and 14.5 points year to date, with management citing acquired-business margin dilution and pricing pressures; the nine-month comparison also included an unplanned plant outage and raw-material purchasing and pricing issues.
- Oilfield Services sales rose 65% in Q3 and 70% year to date as customer activity improved. Margins were lower year over year, with Hurricane Harvey affecting raw-material cost and availability; higher demand also increased support and operating expenses.
- Fuel Specialties sales rose 14% in Q3 and 3% year to date. Q3 gross margin declined 4.0 percentage points, although the nine-month margin improved 0.7 points.
- Octane Additives sales increased, but nine-month gross margin declined 11.7 percentage points, partly due to lower production volumes and higher manufacturing cost per tonne. The segment is expected to decline as its remaining refinery customer transitions to unleaded fuel.
Liquidity, outlook, risks and unusual items
- Operating cash flow fell to $35.2 million from $87.0 million for the first nine months. Management attributed the decline principally to working-capital needs, including the acquired Huntsman business, increased Oilfield Services activity and incentive compensation payments. Adjusted working capital increased $73.0 million to $253.5 million.
- Cash decreased by $36.4 million from year-end 2016. The company repaid a net $40.0 million under its revolving credit facility; $121.0 million remained drawn at quarter-end. The facility provides up to $200.0 million of borrowing through November 2020.
- Net interest expense increased to $6.3 million for the nine months from $2.2 million, reflecting acquisition-related term debt, working-capital borrowing and higher LIBOR. Most cash was held by non-U.S. subsidiaries; management did not expect to repatriate foreign earnings in the foreseeable future.
- No specific earnings or revenue guidance was provided in the supplied filing text. Management noted that interim results are not necessarily indicative of full-year results. It reported sequential Performance Chemicals margin improvement versus Q2 and continued Oilfield Services demand improvement.
- Plant closure and remediation provisions totaled $42.7 million, principally related to the Ellesmere Port site. Unrecognized tax benefits and related interest and penalties were $1.8 million. Guarantees not recorded as liabilities totaled $3.3 million. The company reported no material pending legal proceedings, while noting that numerous claims could have an aggregate material effect.
- Foreign-currency forward contracts produced a $0.6 million loss for the first nine months; management uses derivatives for risk management, not trading. The filing identifies interest-rate, foreign-exchange and raw-material price exposures. Management said there had been no material change in risk factors since the 2016 Form 10-K.
- The company planned to adopt the revenue-recognition standard on January 1, 2018 using the modified retrospective approach and did not expect a material impact. It had not yet determined the effects of new lease-accounting and pension-cost presentation standards.
Important facts for investors to verify
- How much of Performance Chemicals growth and future profitability depends on the Huntsman acquisition, and whether acquired-business margins continue to improve.
- Whether working capital converts to cash as receivables and inventories rise, and whether operating cash flow recovers.
- Whether Oilfield Services demand and margins remain resilient after Hurricane Harvey-related cost and supply effects.
- The outlook for Octane Additives as the remaining customer transitions to unleaded fuel.
- Debt, interest costs, foreign cash availability, and the timing and cost of environmental remediation obligations.