Innospec Inc. — Q2 2017 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the three and six months ended June 30, 2017, compared with the same 2016 periods. Innospec reports four segments: Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives. Performance Chemicals includes the European Differentiated Surfactants business acquired from Huntsman on December 30, 2016.
Financial performance and condition
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $326.3 million | $228.0 million | $620.6 million | $440.1 million |
| Gross profit | $105.1 million | $85.5 million | $196.0 million | $161.7 million |
| Gross margin | 32.2% | 37.5% | 31.6% | 36.7% |
| Operating income | $34.7 million | $28.6 million | $61.1 million | $54.2 million |
| Net income | $26.1 million | $28.9 million | $43.3 million | $47.8 million |
| Diluted EPS | $1.06 | $1.18 | $1.76 | $1.95 |
- Operating cash flow was negative $10.9 million for the first six months, versus positive $57.1 million a year earlier. Capital expenditures were $13.1 million.
- Cash was $48.8 million at June 30, down from $101.9 million at year-end 2016. Current assets were $519.9 million and current liabilities $228.4 million.
- Debt comprised $141.0 million drawn on the revolving facility and a $110.0 million term loan; reported debt net of deferred financing costs was $249.1 million. Finance lease obligations were $5.8 million. The revolving facility has a stated $200 million capacity through November 2020.
- Adjusted working capital, a company-defined non-GAAP measure, increased to $264.8 million from $180.5 million at year-end. Receivables and inventories rose substantially.
Material changes versus prior comparable periods
- Q2 sales rose 43% and first-half sales rose 41%, principally reflecting Huntsman acquisition revenue and stronger Oilfield Services activity. Performance Chemicals sales increased 197% in Q2 and 185% in the first half; Oilfield Services sales rose 64% and 72%, respectively.
- Despite higher gross profit dollars, aggregate gross margin declined. Performance Chemicals margin fell as acquired European business had lower margins and the segment experienced an unplanned plant outage and raw-material purchasing and pricing issues. Octane Additives margins also declined on lower production volumes.
- Net income fell year over year in both periods. Lower other net income and higher interest expense contributed; interest expense was $2.0 million in Q2 and $4.2 million for the first half, reflecting acquisition-related borrowing, working-capital needs and higher LIBOR.
- Fuel Specialties sales were lower, while segment gross margin improved. Oilfield Services returned to operating profitability in Q2 and the first half as customer activity strengthened. Octane Additives sales rose in Q2 due to order timing but fell for the first half.
Outlook, commentary, risks and unusual items
- The filing provides no specific financial guidance. Management says Octane Additives is expected to decline as its remaining refinery customer transitions to unleaded fuel.
- Management attributed the operating cash outflow mainly to Huntsman-related working-capital requirements, increased Oilfield Services activity, shipment timing in Octane Additives and payment of long-term incentive compensation. The company also cited acquisition working-capital funding and timing of customer receipts and supplier payments.
- Q2 included a $1.0 million loss on disposal of a subsidiary related to an indemnity claim. First-half results included a $1.8 million foreign-exchange loss on liquidation of a subsidiary. The prior-year periods benefited from contingent-consideration fair-value credits ($2.4 million in Q2; $4.0 million for the first half).
- Environmental and plant-closure provisions totaled $41.7 million. No material pending legal proceedings were reported; guarantees not recognized as liabilities totaled $5.7 million. Management noted tax examinations covering U.S. state tax years 2012–2014 and a federal examination for 2015, and did not expect resulting adjustments to materially affect financial position.
- Foreign-exchange, floating-rate interest and raw-material cost exposures remain relevant; management reported no significant change in market risks from the 2016 Form 10-K. The company said risk factors had not materially changed. Disclosure controls were assessed as effective; integration of Huntsman internal controls was expected to be completed in 2017.
- The Huntsman purchase-price allocation remained provisional at June 30, with final purchase price and valuation review not yet finalized. The company expected to adopt the new revenue standard on January 1, 2018 and was still evaluating its impact and transition method.
Important facts for investors to verify
- Whether elevated receivables and inventory convert to cash, and whether operating cash flow improves after the acquisition-related working-capital build.
- Performance Chemicals’ margins as integration proceeds and as the effects of the plant outage and raw-material issues unwind.
- Oilfield Services demand and margins, and the timing and scale of the Octane Additives customer’s transition away from leaded fuel.
- Final Huntsman purchase accounting, including the allocation to identifiable assets and goodwill.
- Debt, interest costs and liquidity under the revolving facility, along with environmental closure estimates, tax audit developments and potential tax costs if foreign earnings are repatriated.