Innospec Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Unaudited consolidated financial statements; amounts in U.S. dollars unless noted.
Business context
Innospec reports Fuel Specialties, Active Chemicals and Octane Additives. Fuel Specialties and Active Chemicals operate in markets where the company seeks growth; Octane Additives is a declining market, centered on tetra ethyl lead (TEL).
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $202.1m | $174.0m | $573.9m | $505.9m |
| Gross profit | $57.7m | $54.6m | $168.6m | $160.0m |
| Gross margin | 28.6% | 31.4% | 29.4% | 31.6% |
| Operating income (loss) | $(20.2)m | $20.9m | $26.1m | $57.0m |
| Net income (loss) | $(16.8)m | $30.0m | $29.3m | $49.4m |
| Diluted EPS | $(0.71) | $1.20 | $1.19 | $1.98 |
| Operating cash flow | Not separately stated | Not separately stated | $20.9m | $42.4m |
- Q3 sales rose 16%; nine-month sales rose 13%. Growth was concentrated in Fuel Specialties and Active Chemicals; nine-month Octane Additives sales fell 5%.
- Gross profit increased, but margins contracted. Management attributed Fuel Specialties margin pressure principally to lower-margin product mix and higher raw-material costs. Active Chemicals margins improved.
- Q3 results included the $45.0m NewMarket civil complaint settlement, recorded in Octane Additives operating expenses. Excluding that settlement, reported operating expenses for the segment were up $0.1m year over year in Q3. The filing reports nine-month operating income of $26.1m after the settlement.
- Reported net loss for Q3 included an $8.4m income tax benefit. Management gave an adjusted effective tax rate of 21.2% for Q3 and 20.4% for the first nine months, excluding specified settlement and uncertain-tax-position effects.
Liquidity, debt and balance sheet
- At September 30, cash and cash equivalents were $132.1m, short-term investments $4.8m, and total current assets $375.3m. Current liabilities were $221.4m; working capital was $153.9m.
- Total debt was $90.0m: $25.0m term loan, $50.0m revolving credit and $15.0m NewMarket promissory note. The balance sheet classified $80.0m as current and $10.0m as long-term. Cash exceeded reported debt by $42.1m.
- The credit facility expires February 6, 2012. Management said the company complied with its financial covenants at September 30 and expected to remain compliant through the facility’s remaining term. Covenants include net debt to EBITDA no greater than 2.5:1 and EBITDA to net interest of at least 4.0:1. The facility is secured and restricts certain activities.
- Nine-month operating cash flow was $20.9m, down from $42.4m. Working-capital changes included a $15.7m cash use from inventories and a $7.8m use from receivables. Capital expenditures were $5.9m. Cash increased by $25.0m to $132.1m, supported in part by $43.0m net revolving-credit borrowings.
- Adjusted working capital, as defined by the company, increased $20.2m to $99.2m; management cited increased receivables and strategic inventory builds.
Material changes, outlook and risks
- NewMarket settlement: The September 2011 settlement resolved two civil actions with mutual releases and dismissal with prejudice. Consideration totaled approximately $45.0m: $25.0m cash paid, a $15.0m note payable in three equal annual installments at 1% interest (first due September 10, 2012), and approximately $5.0m in company shares. The settlement drove the Q3 operating loss and increased debt obligations.
- Government-investigation settlement: The company reported $13.1m remaining for fines, penalties, disgorgements and probable compliance-monitor expenses under its $40.2m settlement, with $10.9m due within one year.
- Segment outlook and impairment: TEL demand had declined at an average rate of approximately 10% annually over the prior five years. Innospec expects Octane Additives goodwill impairment charges to continue on an approximate straight-line basis through December 31, 2012; it recorded $1.7m for the first nine months of 2011.
- Management commentary: No specific sales or earnings guidance is provided in the supplied filing text. The company expects 2011 pension-plan cash contributions of approximately $9m, compared with $15.5m in 2010. It received an Iraqi Ministry of Oil order for 2,000 tonnes of TEL; delivery of 160.5 tonnes free of charge is contingent on delivery and payment for the full order and settles specified legacy claims.
- Other exposures: The company had $11.8m of unrecognized tax benefits and related interest and penalties, $23.5m in plant-closure provisions, and $6.3m of contingent guarantees. It noted environmental-estimation uncertainty, foreign-currency and raw-material risks, and restrictive credit-facility terms. Management reported no material change in risk factors from its 2010 Form 10-K.
- Capital allocation and controls: The board increased the 2011 share-repurchase authorization to up to $40m, subject to market conditions. The company repurchased 594,336 shares during September for an average $25.83 per share. Management concluded disclosure controls were effective at quarter-end and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- How the NewMarket settlement, related tax treatment and scheduled note installments affect future earnings, cash flow and liquidity.
- How the company will address the February 2012 credit-facility expiration, including refinancing needs and covenant headroom.
- Whether Fuel Specialties can recover margin pressure from input costs and product mix, and whether Active Chemicals’ growth and margins persist.
- How quickly TEL demand declines, the resulting Octane Additives cash flows and remaining impairment charges through 2012.
- The timing and cash requirements for the remaining government-settlement payments, environmental provisions and uncertain tax positions.