Item 1
Business
When we use the terms “Innospec,” “the Corporation,” “the Company,” “Registrant,” “we,” “us” and “our,” we are referring to Innospec Inc. and its consolidated subsidiaries unless otherwise indicated or the context otherwise requires.
General
Innospec develops, manufactures, blends, markets and supplies specialty chemicals for use as fuel additives, ingredients for personal care, home care, agrochemical, metal extraction and other applications and oilfield chemicals. Our products are sold primarily to oil and gas exploration and production companies, oil refiners, fuel manufacturers and users, formulators of personal care, home care, agrochemical and metal extraction formulations, and other chemical and industrial companies throughout the world. Our fuel additives help improve fuel efficiency, boost engine performance and reduce harmful emissions. Our performance chemicals provide effective technology-based solutions for our customers’ processes or products focused in the Personal Care, Home Care, Agrochemical and Metal Extraction markets. Our Oilfield Services business supplies drilling, completion and production chemicals which make exploration and production more effective, cost­efficient and environmentally friendly. Our Octane Additives business manufactures a fuel additive for use in automotive gasoline.
Segment Information
The Company reports its financial performance based on the four reportable segments described as follows:
• Fuel Specialties
• Performance Chemicals
• Oilfield Services
• Octane Additives
The Fuel Specialties, Performance Chemicals and Oilfield Services segments operate in markets where we actively seek growth opportunities although their ultimate customers are different. The Octane Additives segment revenues may conclude in the early part of 2020 as our one remaining refinery customer transitions to unleaded fuel.
For financial information about each of our segments, see Note 3 of the Notes to the Consolidated Financial Statements.
Fuel Specialties
Our Fuel Specialties segment develops, manufactures, blends, markets and supplies a range of specialty chemical products used as additives to a wide range of fuels. These fuel additive
products help improve fuel efficiency, boost engine performance and reduce harmful emissions; and are used in the efficient operation of automotive, marine and aviation engines, power station generators, and heating oil.
The segment has grown organically through our development of new products to address what we believe are the key drivers in demand for fuel additives. These drivers include increased demand for fuel, focus on fuel economy, changing engine technology and legislative developments. We have also devoted substantial resources towards the development of new and improved products that may be used to improve combustion efficiency.
Our customers in this segment include national oil companies, multinational oil companies and fuel retailers.
Performance Chemicals
Our Performance Chemicals segment provides effective technology-based solutions for our customers’ processes or products focused in the Personal Care, Home Care, Agrochemical and Metal Extraction markets.
This segment has grown through acquisitions, and the development and marketing of innovative products. The focus for our Performance Chemicals segment is to develop high performance products from its technology base in a number of targeted markets.
Our customers in this segment include large multinational companies, manufacturers of personal care and household products and specialty chemical manufacturers operating in agrochemical, metal extraction and other industrial applications.
Oilfield Services
Our Oilfield Services segment develops and markets products to prevent loss of mud in drilling operations, chemical solutions for fracturing, stimulation and completion operations and products for oil and gas production which aid flow assurance and maintain asset integrity.
This segment has been growing strongly in recent years, driven by increased customer activity as the industry has been supported by stable oil prices.
Our customers in this segment include multinational public and independent companies operating currently principally in the Americas.
Octane Additives
Our Octane Additives segment, which we believe is the world’s only producer of tetra ethyl lead (“TEL”), comprises sales of TEL for use in automotive gasoline and provides services in respect of environmental remediation. We are continuing to responsibly manage the decline in the demand for TEL for use in automotive gasoline in line with the transition plans to unleaded gasoline for our one remaining refinery customer. Cost improvement measures continue to be taken to respond to declining market demand. We expect the possible conclusion of revenues from our Octane Additives segment in the early part of 2020.
Sales of TEL for use in automotive gasoline are principally made to state-owned refineries located in North Africa. Our environmental remediation business manages the cleanup of redundant TEL facilities as refineries complete the transition to unleaded gasoline.
Strategy
Our strategy is to develop new and improved products and technologies to continue to strengthen and increase our market positions within our Fuel Specialties, Performance Chemicals and Oilfield Services segments. We also actively continue to assess potential strategic acquisitions, partnerships and other opportunities that would enhance and expand our customer offering. We focus on opportunities that would extend our technology base, geographical coverage or product portfolio. We believe that focusing on the Fuel Specialties, Performance Chemicals and Oilfield Services segments, in which the Company has existing experience, expertise and knowledge, provides opportunities for positive returns on investment with reduced operating risk. We also continue to develop our geographical footprint, consistent with the development of global markets.
Geographical Area Information
Financial information with respect to our domestic and foreign operations is contained in Note 3 of the Notes to the Consolidated Financial Statements.
Working Capital
The nature of our customers’ businesses generally requires us to hold appropriate amounts of inventory in order to be able to respond quickly to customers’ needs. We therefore require corresponding amounts of working capital for normal operations. We do not believe that this is materially different to what our competitors do, with the exception of cetane number improvers, in which case we maintain high enough levels of inventory, as required, to retain our position as market leader in sales of these products.
The purchase of large amounts of certain raw materials across all our segments can create some variations in working capital requirements, but these are planned and managed by the business.
We do not believe that our terms of sale, or purchase, differ markedly from those of our competitors.
Raw Materials and Product Supply
We use a variety of raw materials and chemicals in our manufacturing and blending processes and believe that sources for these are adequate for our current operations. Our major purchases are oleochemicals and derivatives, cetane number improvers, ethylene, various solvents, amines, alcohols, olefin and polyacrylamides.
These purchases account for a substantial portion of the Company’s variable manufacturing costs. These materials are, with the exception of ethylene for our operations in Germany,
readily available from more than one source. Although ethylene is, in theory, available from several sources, it is not permissible to transport ethylene by road in Germany. As a result, we source ethylene for our German operations via a direct pipeline from a neighboring site, making it effectively a single source. Ethylene is used as a primary raw material for our German operations in products representing approximately 4% of Innospec’s sales.
We use long-term contracts (generally with fixed or formula-based costs) and advance bulk purchases to help ensure availability and continuity of supply, and to manage the risk of cost increases. From time to time, for some raw materials, the risk of cost increases is managed with commodity swaps.
We continue to monitor the situation and adjust our procurement strategies as we deem appropriate. The Company forecasts its raw material requirements substantially in advance, and seeks to build long-term relationships and contractual positions with supply partners to safeguard its raw material positions. In addition, the Company operates an extensive risk management program which seeks to source key raw materials from multiple sources and to develop suitable contingency plans.
Intellectual Property
Our intellectual property, including trademarks, patents and licenses, forms a significant part of the Company’s competitive advantage, particularly in the Fuel Specialties, Oilfield Specialties and Performance Chemicals segments. The Company does not, however, consider its business as a whole to be dependent on any one trademark, patent or license.
The Company has a portfolio of trademarks and patents, both granted and in the application stage, covering products and processes in several jurisdictions. The majority of these patents were developed by the Company and, subject to maintenance obligations including the payment of renewal fees, have at least 10 years life remaining.
The trademark “Innospec and the Innospec device” in Classes 1, 2 and 4 of the “International Classification of Goods and Services for the Purposes of the Registration of Marks” are registered in all jurisdictions in which the Company has a significant market presence. The Company also has trademark registrations for certain product names in all jurisdictions in which it has a significant
market presence.
We actively protect our inventions, new technologies, and product developments by filing patent applications and maintaining trade secrets. In addition, we vigorously participate in patent opposition proceedings around the world where necessary to secure a technology base free from infringement of intellectual property.
Competition
Certain markets in which the Company operates are subject to significant competition. The Company competes on the basis of a number of factors including, but not limited to, product quality and performance, specialized product lines, customer relationships and service, and regulatory expertize.
Fuel Specialties:
Fuel Specialties is generally characterized by a small number of competitors, none of which hold a dominant position. We consider our competitive edge to be our proven technical development capacity, independence from major oil companies and strong long-term customer relationships.
Performance Chemicals:
Within the Performance Chemicals segment we operate in the Personal Care, Home Care, Agrochemical and Metal Extraction markets which are highly fragmented, and the Company experiences substantial competition from a large number of multinational and specialty chemical suppliers in each geographical market. Our competitive position in these markets is based on us supplying a superior, diverse product portfolio which solves particular customer problems or enhances the performance of new or existing products. In a number of specialty chemicals markets, we also supply niche product lines, where we enjoy market-leading positions.
Oilfield Services:
Our Oilfield Services segment is very fragmented and although there are a small number of very large competitors, there are also a large number of smaller players focused on specific technologies or regions. Our competitive strength is our proven technology, broad regional coverage and strong customer relationships.
Octane Additives:
We believe our Octane Additives segment is the world’s only producer of TEL and accordingly is the only supplier of TEL for use in automotive gasoline. The segment therefore competes with marketers of products and processes that provide
alternative ways of enhancing octane performance in automotive gasoline.
Research, Development, Testing and Technical Support
Research, product/application development and technical support (“R&D”) provide the basis for the growth of our Fuel Specialties, Performance Chemicals and Oilfield Services segments. Accordingly, the Company’s R&D activity has been, and will continue to be, focused on the development of new products and formulations. Our R&D department provides technical support for all of our reporting segments. Expenditures to support R&D services were $35.4 million, $33.4 million and $31.4 million in 2019, 2018 and 2017, respectively.
We believe that our proven technical capabilities provide us with a significant competitive advantage. In the last five years, the Fuel Specialties segment has developed new detergents, cold flow improvers, stabilizers, lubricity and combustion improver products, in addition to the introduction of many new cost effective fuel additive packages and products for dealing with the dangers of low conductivity. This proven technical capability has also facilitated the development of our leading edge isethionate and taurate product ranges in Performance Chemicals.
Health, Safety and Environmental Matters
We are subject to environmental laws in the countries in which we operate and conduct business. Management believes that the Company is in material compliance with applicable environmental laws and has made the necessary provisions for the continued costs of compliance with environmental laws.
Our principal site giving rise to environmental remediation liabilities is our Ellesmere Port manufacturing site in the United Kingdom. There are also environmental remediation liabilities on a much smaller scale in respect of our other manufacturing sites in the U.S. and Europe. At Ellesmere Port there is a continuing asset retirement program related to certain manufacturing units that have been closed.
We recognize environmental remediation liabilities when they are probable and costs can be reasonably estimated, and asset retirement obligations when there is a legal obligation and costs can be reasonably estimated. This involves anticipating the program of work and the associated future expected costs, and so involves the exercise of judgment by management. We regularly review the future expected costs of remediation and the current estimate is reflected in Note 12 of the Notes to the Consolidated Financial Statements.
The European Union legislation known as the Registration, Evaluation and Authorization of Chemical Substances Regulations (“REACH”) requires most of the Company’s products to be registered with the European Chemicals Agency. Under this legislation the Company has to demonstrate that its products are appropriate for their intended purposes. During this registration and continued evaluation process, the Company incurs expense to test and register its products.
Employees
The Company had approximately 2000 employees in 24 countries as at December 31, 2019.
Available Information
Our corporate web site is www.innospecinc.com. We make available, free of charge, on or through this web site our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such material with, or furnishing it to, the U.S. Securities and Exchange Commission (“SEC”). In addition, the SEC maintains an internet site at http://www.sec.gov
that contains reports, proxy and information statements, and other information that we file electronically with the SEC and state the address of that site.
The Company routinely posts important information for investors on its web site (under Investor Relations). The Company uses this web site as a means of disclosing material, non-public
information and for complying with its disclosure obligations under SEC Regulation FD (“Fair Disclosure”). Accordingly, investors should monitor the Investor Relations portion of the Company’s web site, in addition to following the Company’s press releases, SEC filings, public conference calls, presentations and webcasts.
Item 1A
Item 1A
Risk Factors
The factors described below represent the principal risks associated with our business.
Trends in oil and gas prices affect the level of exploration, development and production activity of our customers, and the demand for our services and products, which could have a material adverse impact on our business.
Demand for our services and products in our Oilfield Services business is particularly sensitive to the level of exploration, development and production activity of, and the corresponding capital spending by, oil and gas companies. The level of exploration, development and production activity is directly affected by trends in demand for and prices of oil and gas, which historically have been volatile and are likely to continue to be volatile. Prices for oil and gas are subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and gas, market uncertainty, and a variety of other economic and political factors that are beyond our control. Even the perception of longer-term lower oil and gas prices by oil and gas companies can similarly reduce or defer major expenditures given the long-term nature of many large-scale development projects. Factors affecting the prices of oil and gas include the level of supply and demand for oil and gas, governmental regulations, including the policies of governments regarding the exploration for and production and development of their oil and gas reserves, weather conditions and natural disasters, worldwide political, military, and economic conditions, the level of oil and gas production by non-OPEC
(“Organization of the Petroleum Exporting Countries”) countries and the available excess production capacity within OPEC, the cost of producing and delivering oil and gas and potential acceleration of the development of alternative power generation, fuels and engine technologies. Any prolonged reduction in oil and gas prices will depress the immediate levels of exploration, development, and production activity which could have a material adverse impact on our results of operations, financial position and cash flows.
We face risks related to our foreign operations that may adversely affect our business.
We serve global markets and operate in certain countries with political and economic instability, including the Middle East, Northern Africa, Asia-Pacific, Eastern Europe and South American regions. Our international operations are subject to numerous international business risks including, but not limited to, geopolitical and economic conditions, risk of expropriation, import and export restrictions, trade wars, exchange controls, national and regional labor strikes, high or unexpected taxes, government royalties and restrictions on repatriation of earnings or proceeds from liquidated assets of overseas subsidiaries. Any of these could have a material adverse impact on our results of operations, financial position and cash flows.
We are subject to extensive regulation of our international operations that could adversely affect our business and results of operations.
Due to our global operations, we are subject to many laws governing international commercial activity, conduct and relations, including those that prohibit improper payments to government
officials, restrict where and with whom we can do business, and limit the products, software and technology that we can supply to certain countries and customers. These laws include, but are not limited to, the U.S. Foreign Corrupt Practices Act and United Kingdom Bribery Act, sanctions and assets control programs administered by the U.S. Department of the Treasury and/or the European Union from time to time, and the U.S. export control laws such as the regulations under the U.S. Export Administration Act, as well as similar laws and regulations in other countries relevant to our business operations. Violations of any of these laws or regulations, which are often complex in their application, may result in criminal or civil penalties that could have a material adverse effect on our results of operations, financial position and cash flows.
We may not be able to consummate, finance or successfully integrate future acquisitions, partnerships or other opportunities into our business, which could hinder our strategy or result in unanticipated expenses and losses.
Part of our strategy is to pursue strategic acquisitions, partnerships and other opportunities to complement and expand our existing business. The success of these transactions depends on our ability to efficiently complete transactions, integrate assets and personnel acquired in these transactions and apply our internal control processes to these acquired businesses. Consummating acquisitions, partnerships or other opportunities and integrating acquisitions involves considerable expense, resources and management time commitments, and our failure to manage these as intended could result in unanticipated expenses and losses. Post-acquisition integration may result in unforeseen difficulties and may deplete significant financial and management resources that could otherwise be available for the ongoing development or expansion of existing operations. Furthermore, we may not realize the benefits of an acquisition in the way we anticipated when we first entered the transaction. Any of these risks could adversely impact our results of operations, financial position and cash flows.
Competition and market conditions may adversely affect our operating results.
In certain markets, our competitors are larger than us and may have greater access to financial, technological and other resources. As a result, competitors may be better able to adapt to changes in conditions in our industries, fluctuations in the costs of raw materials or changes in global economic conditions. Competitors may also be able to introduce new products with enhanced features that may cause a decline in the demand and sales of our products. Consolidation of customers or competitors, or economic problems of customers in our markets could cause a loss of market share for our products, place downward pressure on prices, result in payment delays or non-payment,
or declining plant utilization rates. These risks could adversely impact our results of operations, financial position and cash flows.
Political developments may adversely affect our business
On June 23, 2016, the United Kingdom (U.K.) held a referendum in which voters approved an exit from the European Union (E.U.), commonly referred to as “Brexit”. Subsequently, the U.K. parliament passed the European Union (Notification of Withdrawal) Act 2017, which
conferred power on the U.K. government to give notice to the European Council, under Article 50(2) of the Treaty on European Union, of the U.K.’s intention to withdraw from the European Union. The U.K. submitted this notice to the European Council on March 29, 2017. The U.K. left the E.U. on January 31, 2020. A transition period now exists until December 31, 2020, during which businesses in the U.K. will trade on essentially very similar if not the same terms as before and E.U. law will continue to apply in the U.K. while the detailed legal agreement on the future relationship between the U.K. and the E.U. is being negotiated. If a future trading relationship is not agreed between the U.K. and the E.U. before the end of the transition period then there are likely to be greater restrictions on imports and exports between the U.K. and E.U. member states and increased regulatory complexities for businesses trading goods and services between those jurisdictions. For example, during the proposed transition period, goods first lawfully put on the market in the E.U. or in the U.K. prior to the end of the transition period can circulate between the two markets before they reach the end user, but following the end of the transition period or in a No Deal scenario, they may not be able to do so without complying with additional requirements first.
These political developments may adversely impact our results of operations, financial position and cash flows.
We could be adversely affected by technological changes in our industry.
Our ability to maintain or enhance our technological capabilities, develop and market products and applications that meet changing customer requirements, and successfully anticipate or respond to technological changes in a cost effective and timely manner will likely impact our future business success. We compete on a number of fronts including, but not limited to, product quality and performance. In the case of some of our products, our competitors are larger than us and may have greater access to financial, technological and other resources. Technological changes include, but are not limited to, the development of electric and hybrid vehicles, and the subsequent impact on the demand for gasoline and diesel. Our inability to maintain a technological edge, innovate and improve our products could cause a decline in the demand and sales of our products, and adversely impact our results of operations, financial position and cash flows.
Having a small number of significant customers may have a material adverse impact on our results of operations.
Our principal customers are oil and gas exploration and production companies, oil refineries, personal care companies, and other chemical and industrial companies. These industries are characterized by a concentration of a few large participants. The loss of a significant customer, a material reduction in demand by a significant customer or termination or non-renewal
of a significant customer contract could adversely impact our results of operations, financial position and cash flows.
Our United Kingdom defined benefit pension plan could adversely impact our financial condition, results of operations and cash flows.
Movements in the underlying plan asset value and Projected Benefit Obligation (“PBO”) of our United Kingdom defined benefit pension plan are dependent on actual return on investments as well as our assumptions in respect of the discount rate, annual member mortality rates, future return on assets and future inflation. A change in any one of these assumptions could impact the plan asset value, PBO and pension credit recognized in the income statement. If future plan investment returns prove insufficient to meet future obligations, or should future obligations increase due to actuarial factors or changes in pension legislation, then we may be required to make additional cash contributions. These events could adversely impact our results of operations, financial position and cash flows.
We may have additional tax liabilities.
We are subject to income and other taxes in the U.S. and other jurisdictions. Tax laws are dynamic and subject to change as new laws are passed and new interpretations of the law are issued or applied. Significant judgment is required in estimating our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates are reasonable, any final determination pursuant to tax audits and any related litigation could be materially different to what is reflected in our consolidated financial statements. Should any tax authority disagree with our estimates and determine any additional tax liabilities, including interest and penalties for us, this could adversely impact our results of operations, financial position and cash flows.
Our success depends on our management team and other key personnel, the loss of any of whom could disrupt our business operations.
Our future success will depend in substantial part on the continued services of our senior management. The loss of the services of one or more of our key executive personnel could affect the implementation of our business plan and result in reduced profitability. Our future success also depends on the continued ability to attract, develop, retain and motivate highly-qualified technical, sales and support staff. We cannot guarantee that we will be able to retain our key personnel or attract or retain qualified personnel in the future. If we are unsuccessful in our efforts in this regard, this could adversely impact our results of operations, financial position and cash flows.
Continuing adverse global economic conditions could materially affect our current and future businesses.
Global economic factors affecting our business include, but are not limited to, geopolitical instability in some markets, miles driven by passenger and commercial vehicles, legislation to control fuel quality, impact of alternative propulsion systems, consumer demand for premium personal care and cosmetic products, and oil and gas drilling and production rates. The availability, cost and terms of credit have been, and may continue to be, adversely affected by
the foregoing factors and these circumstances have produced, and may in the future result in, illiquid markets and wider credit spreads, which may make it difficult or more expensive for us to obtain credit. Continuing uncertainties in the U.S. and international markets and economies leading to a decline in business and consumer spending could adversely impact our results of operations, financial position and cash flows.
An information technology system failure may adversely affect our business.
We rely on information technology systems to transact our business. Like other global companies, we have, from time to time, experienced threats to our data and systems. Although we have implemented administrative and technical controls and take protective actions to reduce the risk of cyber incidents and breaches of our information technology, and we endeavor to modify such procedures as circumstances warrant, such measures may be insufficient to prevent physical and electronic break-ins,
cyber-attacks or other security breaches to our computer systems.
As we have disclosed in the second quarter of 2019, we experienced a network security incident that prevented access to certain information technology systems and data within our network. Even after our remediation efforts, our systems, processes, software and network may be vulnerable to internal or external security breaches, computer viruses, malware or other malicious code or cyber-attack, catastrophic events, power interruptions, hardware failures, fire, natural disasters, human error, system failures and disruptions, and other events that could have security consequences. An information technology failure or disruption could prevent us from being able to process transactions with our customers, operate our manufacturing facilities, and properly report those transactions in a timely manner.
Whilst we have insurance coverage in place that may, subject to policy terms and conditions, cover certain aspects of cyber risks, this insurance coverage is subject to certain limitations and may not be applicable to a particular incident or otherwise be sufficient to cover all our losses beyond any coverage limitations. Furthermore, a significant or protracted information technology system failure may result in a material adverse effect on our results of operations, financial position and cash flows.
Decline in our TEL business
The remaining sales of the Octane Additives business are now concentrated to one remaining refinery customer. When this customer chooses to cease using TEL as an octane enhancer then the Company’s future operating income and cash flows from operating activities will be materially impacted. While we cannot be certain, we expect the possible conclusion of revenues from our Octane Additives segment in the early part of 2020.
The sales of the AvTel product line are recorded within our Fuel Specialties business. The piston aviation industry has been, and is currently, researching a safe replacement fuel to replace leaded fuel. While we expect that at some point in the future a replacement fuel will be identified, trialed and supplied to the industry, there is no currently known replacement. In addition, there is no clear timescale on the legislation of a replacement product. If a suitable
product is identified and the use of leaded fuel is prohibited in piston aviation the Company’s future operating income and cash flows from operating activities would be adversely impacted.
We are exposed to fluctuations in foreign currency exchange rates, which may adversely affect our results of operations.
We generate a portion of our revenues and incur some operating costs in currencies other than the U.S. dollar. In addition, the financial position and results of operations of some of our overseas subsidiaries are reported in the relevant local currency and then translated to U.S. dollars at the applicable currency exchange rates for inclusion in our consolidated financial statements. Fluctuations in these currency exchange rates affect the recorded levels of our assets and liabilities, results of operations and cash flows.
The primary exchange rate fluctuation exposures we have are with the European Union euro, British pound sterling and Brazilian real. Exchange rates between these currencies and the U.S. dollar have fluctuated in recent years and may continue to do so. We cannot accurately predict future exchange rate variability among these currencies or relative to the U.S. dollar. While we take steps to manage currency exchange rate exposure, including entering into hedging transactions, we cannot eliminate all exposure to future exchange rate variability. These exchange risks could adversely impact our results of operations, financial position and cash flows.
Sharp and unexpected fluctuations in the cost of our raw materials and energy could adversely affect our profit margins.
We use a variety of raw materials, chemicals and energy in our manufacturing and blending processes. Many of these raw materials are derived from petrochemical-based and vegetable-based feedstocks which can be subject to periods of rapid and significant cost instability. These fluctuations in cost can be caused by political instability in oil producing nations and elsewhere, weather conditions or other factors influencing global supply and demand of these materials, over which we have little or no control. We use long-term contracts (generally with fixed or formula-based costs) and advance bulk purchases to help ensure availability and continuity of supply, and to manage the risk of cost increases. From time to time, we have entered into hedging arrangements for certain utilities and raw materials, but do not typically enter into hedging arrangements for all raw materials, chemicals or energy costs. If the costs of raw materials, chemicals or energy increase, and we are not able to pass on these cost increases to our customers, then profit margins and cash flows from operating activities would be adversely impacted. If raw material costs increase significantly, then our need for working capital could increase. Any of these risks could adversely impact our results of operations, financial position and cash flows.
A disruption in the supply of raw materials or transportation services would have a material adverse impact on our results of operations.
Although we try to anticipate problems with supplies of raw materials or transportation services by building certain inventories of strategic importance, transport operations are
exposed to various risks such as extreme weather conditions, natural disasters, technological problems, work stoppages as well as transportation regulations. If the Company experiences transportation problems, or if there are significant changes in the cost of these services, the Company may not be able to arrange efficient alternatives and timely means to obtain raw materials or ship finished products, which could adversely impact our results of operations, financial position and cash flows.
A high concentration of significant stockholders may have a material adverse impact on our stock price.
Approximately 48% of our common stock is held by five stockholders. A decision by any of these, or other substantial, stockholders to sell all or a significant part of its holding, or a sudden or unexpected disposition of our stock, could result in a significant decline in our stock price which could in turn adversely impact our ability to access equity markets which in turn could adversely impact our results of operations, financial position and cash flows.
Failure to protect our intellectual property rights could adversely affect our future performance and cash flows.
Failure to maintain or protect our intellectual property rights may result in the loss of valuable technologies, or us having to pay other companies for infringing on their intellectual property rights. Measures taken by us to protect our intellectual property may be challenged, invalidated, circumvented or rendered unenforceable. In addition, international intellectual property laws may be more restrictive or may offer lower levels of protection than under U.S. law. We may also face patent infringement claims from our competitors which may result in substantial litigation costs, claims for damages or a tarnishing of our reputation even if we are successful in defending against these claims, which may cause our customers to switch to our competitors. Any of these events could adversely impact our results of operations, financial position and cash flows.
Our products are subject to extensive government scrutiny and regulation.
We are subject to regulation by federal, state, local and foreign government authorities. In some cases, we need government approval of our products, manufacturing processes and facilities before we may sell certain products. Many products are required to be registered with the U.S. Environmental Protection Agency (EPA), with the European Chemicals Agency (ECHA) and with comparable government agencies elsewhere. We are also subject to ongoing reviews of our products, manufacturing processes and facilities by government authorities, and must also produce product data and comply with detailed regulatory requirements.
In order to obtain regulatory approval of certain new products we must, among other things, demonstrate that the product is appropriate and effective for its intended uses, that the product has been appropriately tested for safety and that we are capable of manufacturing the product in accordance with applicable regulations. This approval process can be costly, time consuming, and subject to unanticipated and significant delays. We cannot be sure that necessary approvals will be granted on a timely basis or at all. Any delay in obtaining, or any
failure to obtain or maintain, these approvals would adversely affect our ability to introduce new products and to generate income from those products. New or stricter laws and regulations may be introduced that could result in additional compliance costs and prevent or inhibit the development, manufacture, distribution and sale of our products. Such outcomes could adversely impact our results of operations, financial position and cash flows.
Legal proceedings and other claims could impose substantial costs on us.
We are from time to time involved in legal proceedings that result from, and are incidental to, the conduct of our business, including employee and product liability claims. Although we maintain insurance to protect us against a variety of claims, if our insurance coverage is not adequate to cover such claims, then we may be required to pay directly for such liabilities. Such outcomes could adversely impact our results of operations, financial position and cash flows.
Environmental liabilities and compliance costs could have a substantial adverse impact on our results of operations.
We operate a number of manufacturing sites and are subject to extensive federal, state, local and foreign environmental, health and safety laws and regulations, including those relating to emissions to the air, discharges to land and water, and the generation, handling, treatment and disposal of hazardous waste and other materials on these sites. We operate under numerous environmental permits and licenses, many of which require periodic notification and renewal, which is not automatic. New or stricter laws and regulations could increase our compliance burden or costs and adversely affect our ability to develop, manufacture, blend, market and supply products.
Our operations, and the operations of prior owners of our sites, pose the risk of environmental contamination which may result in fines or criminal sanctions being imposed or require significant amounts in remediation payments.
We anticipate that certain manufacturing sites may cease production over time and on closure, will require safely decommissioning and some environmental remediation. The extent of our obligations will depend on the future use of the sites that are affected and the environmental laws in effect at the time. We currently have made a decommissioning and remediation provision in our consolidated financial statements based on current known obligations, anticipated plans for sites and existing environmental laws. If there were to be unexpected or unknown contamination at these sites, or future plans for the sites or environmental laws change, then current provisions may prove inadequate, which could adversely impact our results of operations, financial position and cash flows.
The inability of counterparties to meet their contractual obligations could have a substantial adverse impact on our results of operations.
We sell products to oil companies, oil and gas exploration and production companies and chemical companies throughout the world. Credit limits, ongoing credit evaluation and
account monitoring procedures are used to minimize bad debt risk. Collateral is not generally required. We have in place a credit facility with a syndicate of banks. From time to time, we use derivatives, including interest rate swaps, commodity swaps and foreign currency forward exchange contracts, in the normal course of business to manage market risks. We enter into derivative instruments with a diversified group of major financial institutions in order to manage the exposure to non-performance
of such instruments.
We remain subject to market and credit risks including the ability of counterparties to meet their contractual obligations and the potential non-performance
of counterparties to deliver contracted commodities or services at the contracted price. The inability of counterparties to meet their contractual obligations could have an adverse impact on our results of operations, financial position and cash flows.
The provisions of our revolving credit facility may restrict our ability to incur additional indebtedness or to otherwise expand our business.
Our revolving credit facility contains restrictive clauses which may limit our activities, and operational and financial flexibility. We may not be able to borrow under the revolving credit facility if an event of default under the terms of the facility occurs. An event of default under the credit facility includes a material adverse change to our assets, operations or financial condition, and certain other events. The revolving credit facility also contains a number of restrictions that limit our ability, among other things, and subject to certain limited exceptions, to incur additional indebtedness, pledge our assets as security, guarantee obligations of third parties, make investments, undergo a merger or consolidation, dispose of assets or materially change our line of business.
In addition, the revolving credit facility requires us to meet certain financial ratios, including ratios based on net debt to earnings before income tax, depreciation and amortization (“EBITDA”) and net interest expense to EBITDA. Net debt, net interest expense and EBITDA are non-GAAP
measures of liquidity defined in the credit facility. Our ability to meet these financial covenants depends upon the future successful operating performance of the business. If we fail to comply with financial covenants, we would be in default under the revolving credit facility and the maturity of our outstanding debt could be accelerated unless we were able to obtain waivers from our lenders. If we were found to be in default under the revolving credit facility, it could adversely impact our results of operations, financial position and cash flows.
Our business is subject to the risk of manufacturing disruptions, the occurrence of which would adversely affect our results of operations.
We are subject to hazards which are common to chemical manufacturing, blending, storage, handling and transportation. These hazards include fires, explosions, remediation, chemical spills and the release or discharge of toxic or hazardous substances together with the more generic risks of labor strikes or slowdowns, mechanical failure in scheduled downtime, extreme weather or transportation interruptions. These hazards could result in loss of life,
severe injury, property damage, environmental contamination and temporary or permanent manufacturing cessation. Any of these factors could adversely impact our results of operations, financial position and cash flows.
Domestic or international natural disasters, pandemics or terrorist attacks may disrupt our operations, decrease the demand for our products or otherwise have an adverse impact on our business.
Chemical related assets, and U.S. corporations such as us, may be at greater risk of future terrorist attacks than other possible targets in the U.S., the United Kingdom and throughout the world. Extraordinary events such as natural disasters and pandemics may negatively affect local economies, including those of our customers or suppliers. The occurrence and consequences of such events cannot be predicted, but they can adversely impact economic conditions in general and in our specific markets. The resulting damage from such events could include loss of life, severe injury and property damage or site closure. Any of these matters could adversely impact our results of operations, financial position and cash flows.
While Innospec maintains business continuity plans that are intended to allow it to continue operations or mitigate the effects of events that could disrupt its business, Innospec cannot provide assurances that its plans would fully protect it from all such events. In addition, insurance maintained by Innospec to protect against property damage, loss of business and other related consequences resulting from catastrophic events is subject to coverage limitations, depending on the nature of the risk insured. This insurance may not be sufficient to cover all of Innospec’s damages or damages to others in the event of a catastrophe. In addition, insurance related to these types of risks may not be available now or, if available, may not be available in the future at commercially reasonable rates.
We may be exposed to certain regulatory and financial risks related to climate change
The outcome of new or potential legislation or regulation in the U.S. and other jurisdictions in which we operate may result in new or additional requirements, additional charges to fund energy efficiency activities, fees or restrictions on certain activities. Compliance with these initiatives may also result in additional costs to us, including, among other things, increased production costs, additional taxes, reduced emission allowances or additional restrictions on production or operations. Any adopted future climate change regulations could also negatively impact our ability to compete with companies situated in areas not subject to such limitations. Even without such regulation, increased public awareness and adverse publicity about potential impacts on climate change emanating from us or our industry could harm us. We may not be able to recover the cost of compliance with new or more stringent laws and regulations, which could adversely affect our business and negatively impact our growth. Furthermore, the potential impacts of climate change and related regulation on our customers are highly uncertain and may adversely affect us.
Item 1B
Item 1B
Unresolved Staff Comments
None.
Item 2
Item 2
Properties
A summary of the Company’s principal properties is shown in the following table. Each of these properties is owned by the Company except where otherwise noted:
Location
Reporting Segment
Operations
Englewood, Colorado(1)
Fuel Specialties and Performance Chemicals
Corporate Headquarters
Business Teams
Sales/Administration
Newark, Delaware(1)
Fuel Specialties
Research & Development
Herne, Germany
Fuel Specialties
Sales/Manufacturing/Administration
Research & Development
Vernon, France
Fuel Specialties
Sales/Manufacturing/Administration
Research & Development
Moscow, Russia(1)
Fuel Specialties
Sales/Administration
Leuna, Germany
Fuel Specialties
Sales/Manufacturing/Administration
Research & Development
Ellesmere Port, United Kingdom
Fuel Specialties, Performance Chemicals and Octane Additives
European Headquarters
Business Teams
Sales/Manufacturing/Administration
Research & Development
Fuel Technology Center
Beijing, China(1)
Fuel Specialties and Performance Chemicals
Sales/Administration
Singapore(1)
Fuel Specialties and Performance Chemicals
Asia-Pacific Headquarters
Business Teams
Sales/Administration
Milan, Italy(1)
Fuel Specialties and Performance Chemicals
Sales/Administration
Rio de Janeiro, Brazil(1)
Fuel Specialties, Performance Chemicals and Oilfield Services
Sales/Administration
High Point, North Carolina
Performance Chemicals
Manufacturing/Administration
Research & Development
Salisbury, North Carolina
Performance Chemicals
Manufacturing/Administration
Research & Development
Chatsworth, California(1)
Performance Chemicals
Sales/Manufacturing/Administration
Saint Mihiel, France
Performance Chemicals
Manufacturing/Administration/Research & Development
Castiglione, Italy
Performance Chemicals
Manufacturing/Administration/Research & Development
Barcelona, Spain(1)
Performance Chemicals
Manufacturing/Administration/Research & Development
Oklahoma City, Oklahoma
Oilfield Services
Sales/Manufacturing/Administration
Midland, Texas
Oilfield Services
Sales/Manufacturing/Administration
Pleasanton, Texas
Oilfield Services
Sales/Manufacturing/Administration
Location
Reporting Segment
Operations
Sugar Land, Texas(1)
Oilfield Services
Sales/Administration/Research & Development
The Woodlands, Houston, Texas(1)
Oilfield Services
Sales/Administration/Research & Development
Williston, North Dakota
Oilfield Services
Sales/Warehouse
Casper, Wyoming(1)
Oilfield Services
Warehouse
Zug, Switzerland(1)
Octane Additives
Sales/Administration
(1)
Leased property
Manufacturing Capacity
We believe that our plants and supply agreements are sufficient to meet current sales levels. Operating rates of the plants are generally flexible and varied with product mix and normal sales demand swings. We believe that all of our facilities are maintained to appropriate levels and in sufficient operating condition though there remains an ongoing need for maintenance and capital investment.
Item 3
Item 3
Legal Proceedings
Legal matters
While we are involved from time to time in claims and legal proceedings that result from, and are incidental to, the conduct of our business including business and commercial litigation, employee and product liability claims, there are no material pending legal proceedings to which the Company or any of its subsidiaries is a party, or of which any of the Company’s property is subject. It is possible, however, that an adverse resolution of an unexpectedly large number of such individual claims or proceedings could in the aggregate have a material adverse effect on results of operations for a particular year or quarter.
Item 4
Item 4
Mine Safety Disclosures
Not applicable.
PART II
Item 5
Item 5
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information and Holders
The Company’s common stock is listed on the NASDAQ under the symbol “IOSP.” As of February 12, 2020 there were 793 registered holders of the common stock.
Unregistered Sales of Equity Securities
There were no unregistered sales of equity securities during the fourth quarter of 2019.
Issuer Purchases of Equity Securities
During 2019 the Company made no open market repurchases of our common stock.
On November 6, 2018 the Company announced that its board of directors had approved a share repurchase program for the repurchase of up to $100 million of Innospec’s common stock over the following three years. During the year ended December 31, 2019, no shares of our common stock were repurchased by the Company under this share repurchase program.
During the quarter ended December 31, 2019 the company has purchased its common stock in connection with the exercising of stock options by employees. The following table provides information about our repurchases of equity securities in the period.
Issuer Purchases of Equity Securities
Stock Price Performance Graph
The graph below compares the cumulative total return to stockholders on the common stock of the Corporation, S&P 500 Index, NASDAQ Composite Index and Russell 2000 Index since December 31, 2014, assuming a $100 investment and the re-investment
of any dividends thereafter.
Value of $100 Investment made December 31, 2014*
* Excludes purchase commissions.
Item 6
Item 6
Selected Financial Data
FINANCIAL HIGHLIGHTS
(1)
The effective tax rate is calculated as income taxes as a percentage of income before income taxes. Income taxes are impacted in 2017 by the provisional estimates recorded in respect of the Tax Cuts and Jobs Act of 2017 (“Tax Act”), and in 2018 by the finalization and recording of additional taxes due as a consequence of the Tax Act. Income taxes in 2019 are calculated under the new legislation of the Tax Act.
(2)
Current ratio is defined as current assets divided by current liabilities.
QUARTERLY SUMMARY
Item 7
Item 7
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion should be read in conjunction with our consolidated financial statements and the notes thereto.
EXECUTIVE OVERVIEW
In 2019, we continued to focus on the organic growth of our portfolio and this delivered in line with our expectations. Sales revenue growth across the group has been driven by new product development and customer adoption of the strong product portfolio in our strategic businesses.
Octane Additives continued to supply the one remaining customer in motor gasoline, albeit at reduced levels, consistent with the customer’s transition to unleaded fuel.
CRITICAL ACCOUNTING ESTIMATES
Note 2 of the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of the consolidated financial statements.
Environmental Liabilities
We are subject to environmental laws in the countries in which we conduct business. Our principal site giving rise to environmental remediation liabilities is the Octane Additives manufacturing site at Ellesmere Port in the United Kingdom. There are also environmental remediation liabilities on a much smaller scale in respect of our other manufacturing sites in the U.S. and Europe. At Ellesmere Port there is a continuing asset retirement program related to certain manufacturing units that have been closed.
Remediation provisions at December 31, 2019 amounted to $49.3 million and relate principally to our Ellesmere Port site in the United Kingdom. We recognize environmental liabilities when they are probable and costs can be reasonably estimated, and asset retirement obligations when there is a legal obligation and costs can be reasonably estimated. The Company has to anticipate the program of work required and the associated future expected costs, and comply with environmental legislation in the countries in which it operates or has operated in. We develop these assumptions utilizing the latest information available together with recent costs. While we believe our assumptions for environmental liabilities are reasonable, they are subjective judgements and it is possible that variations in any of the assumptions will result in materially different calculations to the liabilities we have reported.
Income Taxes
We are subject to income and other taxes in the U.S. and other jurisdictions. Tax laws are dynamic and subject to change as new laws are passed and new interpretations of the law are issued or applied.
The calculation of our tax liabilities involves evaluating uncertainties in the application of accounting principles and complex tax regulations. We recognize liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes will be required. If we ultimately determine that payment of these amounts is unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary.
We also recognize tax benefits to the extent that it is more likely than not that our positions will be sustained, based on technical merits of the position, when challenged by the taxing authorities. To the extent that we prevail in matters for which liabilities have been established, or are required to pay amounts in excess of our liabilities, our effective tax rate in a given period may be materially affected. An unfavourable tax settlement may require cash payments and result in an increase in our effective tax rate in the year of resolution. We report interest and penalties related to uncertain tax positions as income taxes. For additional information regarding uncertain income tax positions, see Note 10 of the Notes to the Consolidated Financial Statements.
Pensions
The Company maintains a defined benefit pension plan covering a number of its current and former employees in the United Kingdom. The Company also has other smaller pension arrangements in the U.S. and overseas as disclosed in Note 9 of the Notes to the Consolidated Financial Statements. The United Kingdom plan is closed to future service accrual, but has a large number of deferred and current pensioners.
Movements in the underlying plan asset value and Projected Benefit Obligation (“PBO”) are dependent on actual return on investments as well as our assumptions in respect of the discount rate, annual member mortality rates, future return on assets and future inflation. A change in any one of these assumptions could impact the plan asset value, PBO and pension charge recognized in the income statement. Such changes could adversely impact our results of operations and financial position. For example, a 0.25% change in the discount rate assumption would change the PBO by approximately $24 million while the net pension credit for 2020 would change by approximately $0.1 million. A 0.25% change in the level of price inflation assumption would change the PBO by approximately $18 million and the net pension credit for 2020 would change by approximately $1.1 million.
Further information is provided in Note 9 of the Notes to the Consolidated Financial Statements.
Goodwill
The Company’s reporting units, the level at which goodwill is assessed for potential impairment, are consistent with the reportable segments. The components in each segment (including products, markets and competitors) have similar economic characteristics and the segments, therefore, reflect the lowest level at which operations and cash flows can be sufficiently distinguished, operationally and for financial reporting purposes, from the rest of the Company.
To test for impairment the Company performs a qualitative assessment to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a segment is less than the carrying amount prior to performing the quantitative goodwill impairment test. Factors utilized in the qualitative assessment process include macroeconomic conditions; industry and market considerations; cost factors; overall financial performance; and Company specific events.
If a quantitative test is required, we assess the fair value based on projected post-tax
cash flows discounted at the Company’s weighted average cost of capital. These fair value techniques require management judgment and estimates including revenue growth rates, projected operating margins, changes in working capital and discount rates. We would develop these assumptions by considering recent financial performance and trends and industry growth estimates. While we believe our assumptions for impairment assessments are reasonable, they are subjective judgments, and it is possible that variations in any of the assumptions will result in materially different calculations of any potential impairment charges.
At December 31, 2019 we had $363.0 million of goodwill relating to our Fuel Specialties, Performance Chemicals and Oilfield Services segments. Our impairment assessment concluded that there had been no impairment of goodwill in respect of those reporting segments.
Property, Plant and Equipment and Other Intangible Assets (Net of Depreciation and Amortization, respectively)
As at December 31, 2019 we had $198.7 million of property, plant and equipment and $113.5 million of other intangible assets (net of depreciation and amortization, respectively), that are discussed in Notes 5 and 8 of the Notes to the Consolidated Financial Statements, respectively. These long-lived assets relate to all of our reporting segments and are being amortized or depreciated straight-line over periods of up to 17 years in respect of the other intangible assets and up to 25 years in respect of the property, plant and equipment.
We continually assess the markets and products related to these long-lived assets, as well as their specific carrying values, and have concluded that these carrying values, and amortization and depreciation periods, remain appropriate.
RESULTS OF OPERATIONS
The following table provides operating income by reporting segment:
Results of Operations - Fiscal 2019 compared to Fiscal 2018:
Financial information with respect to our domestic and foreign operations is contained in Note 3 of the Notes to the Consolidated Financial Statements.
Fuel Specialties
Net sales:
the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:
Lower volumes in the Americas were primarily driven by a specific issue in the second half of 2019 related to disruption from one supplier. Volumes in EMEA and ASPAC were higher, driven by increased demand for our products and technology. Price and product mix in the Americas, EMEA and ASPAC benefited from increased sales of higher margin products. AvTel volumes were higher than the prior year due to variations in the demand from customers, partly offset by an adverse price and product mix. EMEA and ASPAC were negatively impacted by exchange rate movements year over year, driven by a weakening of the British pound sterling and the European Union euro against the U.S. dollar.
Gross margin:
the year on year increase of 1.1 percentage points benefitted from an improvement in the mix of product sales.
Operating expenses:
the year on year increase of $9.2 million was driven by increased selling expenses including higher agents’ commissions and higher personnel related performance-based remuneration due to increased share-based compensation accruals.
Performance Chemicals
Net sales:
the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:
Lower volumes in the Americas and EMEA were driven by a customer taking some volume in-house.
Higher volumes in ASPAC were driven by increased demand for our Personal Care products, partly offset by an adverse price and product mix. Price and product mix in the Americas benefitted from increased sales of higher margin products, while EMEA was adversely impacted by lower raw material prices driving lower selling prices for certain products. EMEA and ASPAC were negatively impacted by exchange rate movements year
over year, due to a weakening of the British pound sterling and the European Union euro against the U.S. dollar.
Gross margin:
the year on year increase of 2.5 percentage points was driven by an improved sales mix, lower raw material prices and the continued benefit of several improvement projects.
Operating expenses:
the year on year decrease of $1.4 million was primarily due to the benefit of a weaker European Union euro against the U.S. dollar and lower costs as a result of the closure of our operation in Belgium in the prior year.
Oilfield Services
Net sales:
the year on year increase of $79.3 million, or 20 percent, was due to improved customer activity in stimulation and production driving increased demand for our technology and customer service. Sales of higher margin products have benefited the price and product mix.
Gross margin:
the year on year increase of 0.7 percentage points was due to an improved customer and product mix leading to increased sales of higher margin products.
Operating expenses:
the year on year increase of $11.9 million was driven by higher selling and technical support expenses required to deliver the increase in customer demand.
Octane Additives
Net sales:
were $21.0 million for 2019 compared to $33.7 million in 2018. Reduced sales are in line with our expectations as the one remaining customer moves closer to completing their transition to unleaded fuel.
Gross margin:
the year on year decrease of 27.8 percentage points was due to lower production volumes spread over the predominantly fixed cost of manufacturing operations.
Operating expenses:
the year on year increase of $0.2 million was principally due to higher year-end
provisions for personnel related performance-based remuneration.
Other Income Statement Captions
Corporate costs:
the year on year increase of $2.0 million primarily relates to higher personnel related performance-based remuneration including higher share-based compensation accruals; partly offset by a reduction for the amortization of our internally developed software following the completed amortization of our first deployment to the Americas which ended in the third quarter of 2018, together with the benefit of a weakening of the British pound sterling against the U.S. dollar for our United Kingdom cost base.
Restructuring charge:
there was no charge in 2019 compared to a charge of $7.1 million in the prior year related to the closure costs, including redundancies and onerous leases, for our operation in Belgium.
Other net income/(expense):
for 2019 and 2018, includes the following:
Interest expense, net:
was $4.8 million for 2019 compared to $6.9 million in the prior year, driven by lower average net debt as the business generated cash inflows.
Income taxes:
The effective tax rate was 25.4% and 35.4% in 2019 and 2018, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 22.6% in 2019 compared with 23.7% in 2018. The Company believes that this adjusted effective tax rate, a non-GAAP
financial measure, provides useful information to investors and may assist them in evaluating the Company’s underlying performance and identifying operating trends. In addition, management uses this non-GAAP
financial measure internally to evaluate the Company’s operations and for planning and forecasting in subsequent periods.
The most significant factors impacting on our effective tax rate in 2019 are explained in Note 10 of the Notes to the Consolidated Financial Statements.
Results of Operations - Fiscal 2018 compared to Fiscal 2017:
Financial information with respect to our domestic and foreign operations is contained in Note 3 of the Notes to the Consolidated Financial Statements.
Fuel Specialties
Net sales:
the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:
Volumes in all our regions were higher, driven by increased demand for our product technology and customer service. Price and product mix in the Americas benefited from increased sales of higher margin products. AvTel volumes were higher than the prior year due to variations in the timing and level of demand from customers. EMEA and ASPAC benefited from favorable exchange rate movements year over year, driven by a strengthening of the British pound sterling and the European Union euro against the U.S. dollar.
Gross margin:
the year on year decrease of 2.0 percentage points was adversely affected by the mix of product sales when compared to a strong prior year comparative.
Operating expenses:
the year on year decrease of $1.8 million was driven by a reduction in the provisions for doubtful debts and lower accruals for agents’ commissions, partly offset by increased other expenses to support the business growth.
Performance Chemicals
Net sales:
the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:
Increased demand for Personal Care led to significantly higher volumes in the Americas, together with a favorable price and product mix from increased sales of higher margin products. EMEA benefited from higher volumes in both Personal Care and Home Care, while ASPAC volumes were higher due to increased demand for Personal Care being partly offset by lower demand for Home Care. ASPAC was impacted by adverse price and product mix due to lower sales of higher margin products. EMEA and ASPAC benefited from favorable exchange rate movements year over year, driven by a strengthening of the British pound sterling and the European Union euro against the U.S. dollar.
Gross margin:
the year on year increase of 2.7 percentage points was driven by the benefit of several improvement projects and favorable manufacturing variances due to higher production volumes.
Operating expenses:
the year on year increase of $9.6 million is due to additional personnel-related expenses to support the business growth, including increased performance-related compensation accruals, together with additional amortization for our new information system platform and the adverse impact of exchange rate movements year over year.
Oilfield Services
Net sales:
the year on year increase of $96.2 million was due to increased customer activity in stimulation and completion, following the rise in crude oil prices in the first nine months of the year. Overall volumes increased by 26 percent year on year, together with a favorable price and product mix of 6 percent.
Gross margin:
the year on year decrease of 3.3 percentage points, was due to the mix of customer activity, adverse raw material pricing and higher transportation and labor costs.
Operating expenses:
the year on year increase of $8.5 million was due to higher selling and technical support expenses required to deliver the increase in customer demand partly offset by a reduction in other expenses. The reduction in other expenses is driven by lower general and administration costs due to effective cost control, together with lower amortization of acquisition related intangible assets as some of the acquired assets have become fully amortized.
Octane Additives
Net sales:
decreased by $25.4 million compared to the prior year, due to the expected reduction in the demand from our one remaining refinery customer.
Gross margin:
the year on year decrease of 14.9 percentage points was due to higher manufacturing costs as a result of lower production volumes to align with reduced customer demand.
Operating expenses:
the year on year decrease of $1.1 million was driven by the release of historic provisions which are no longer required, either due to the settlement of disputed liabilities or to the passing of the relevant time limit under statute of limitations.
Other Income Statement Captions
Corporate costs:
the year on year increase of $3.6 million relates to higher personnel-related compensation accruals including a new long-term incentive plan and higher costs for the additional corporate services required to support our enlarged group following our growth through acquisitions in recent years. There has also been the adverse effect of a stronger British pound sterling against the U.S. dollar for our United Kingdom cost base.
Restructuring charge:
a charge of $7.1 million primarily relates to the closure costs including redundancies and onerous leases for our operation in Belgium.
Loss on disposal of subsidiary:
there was a loss in the prior year of $0.9 million for an indemnity claim in relation to residual testing in the Aroma Chemicals business which was sold in 2015.
Foreign exchange loss on liquidation of subsidiary:
the $1.8 million loss in the prior year related to the reclassification of historic foreign exchange translations of net assets from accumulated other comprehensive losses, for our captive insurance company which was liquidated. There has been no corresponding charge in the current year.
Other net income/(expense):
for 2018 and 2017, includes the following:
Interest expense, net:
was $6.9 million in 2018 compared to $8.2 million in 2017 driven by lower average net debt as the business generated cash inflows.
Income taxes:
The effective tax rate was 35.4% and 51.8% in 2018 and 2017, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 23.7% in 2018 compared with 20.2% in 2017. The Company believes that this adjusted effective tax rate, a non-GAAP
financial measure, provides useful information to investors and may assist them in evaluating the Company’s underlying performance and identifying operating trends. In addition, management uses this non-GAAP
financial measure internally to evaluate the Company’s operations and for planning and forecasting in subsequent periods.
The most significant factor impacting our effective tax rate in 2018 and 2017 is the recognized implications of the Tax Act.
On December 22, 2017, the same date the Tax Act was enacted, SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provided guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete their accounting under ASC 740, Income Taxes. Our accounting for the impact of the Tax Act under SAB 118 is now complete.
The deemed repatriation transition tax (“Transition Tax”) is a tax on certain previously untaxed accumulated earnings and profits (“E&P”) of the Company’s non-U.S.
subsidiaries. At December 31, 2017, we were able to reasonably estimate the Transition Tax and recorded a provisional Transition Tax obligation of $47.7 million. On the basis of revised E&P computations that were completed during the reporting period, we adjusted our Transition Tax estimate to $61.1 million. Net of related consequential impacts recorded in our 2017 U.S. federal income tax return, we recorded an additional $12.3 million income tax expense in the fourth quarter of 2018. Our accounting in relation to the Transition Tax is now complete.
LIQUIDITY AND FINANCIAL CONDITION
Working Capital
The Company believes that adjusted working capital, a non-GAAP
financial measure, provides useful information to investors in evaluating the Company’s underlying performance and identifying operating trends. Management uses this non-GAAP
financial measure internally to allocate resources and evaluate the performance of the Company’s operations. Items excluded from the adjusted working capital calculation are listed in the table below and represent factors which do not fluctuate in line with the day to day working capital needs of the business.
In 2019 our working capital decreased by $40.5 million, while our adjusted working capital decreased by $5.1 million. The difference is primarily due to changes in cash and cash equivalents and long-term debt, together with the exclusion of the current portion of operating lease liabilities from our adjusted working capital.
We had a $12.3 million increase in trade and other accounts receivable driven by higher sales in our Oilfield Services segment. Days’ sales outstanding in our Fuel Specialties segment remained unchanged at 52 days; decreased in our Performance Chemicals segment from 65 days to 64 days; and increased from 56 days to 66 days in our Oilfield Services segment.
We had a $3.4 million decrease in inventories following the expected high demand in the fourth quarter, in particular for our Oilfield Services segment. Days’ sales in inventory in our Fuel Specialties segment increased from 90 days to 97 days; increased in our Performance Chemicals segment from 59 days to 66 days; and decreased from 82 days to 71 days in our Oilfield Services segment.
Prepaid expenses increased $3.1 million, from $11.6 million to $14.7 million due to the timing of invoices received for new prepayments.
We had a $17.1 million increase in accounts payable and accrued liabilities due to the timing of supplier payments and higher accruals for share-based payments linked to the increase in the Innospec share price during the year. Creditor days (including GRNI) in our Fuel Specialties segment increased from 43 days to 52 days; increased in our Performance Chemicals segment from 52 days to 54 days; and decreased in our Oilfield Services segment from 49 days to 43 days.
Operating Cash Flows
We generated cash from operating activities of $161.6 million in 2019 compared to cash inflows of $104.9 million in 2018. Year over year cash from operating activities has benefitted from our effective control of working capital across our business, in particular our Oilfield Services segment has controlled inventory levels while sales have significantly increased year over year. There has also been a favorable cash flow from the timing of income tax payments.
Cash
At December 31, 2019 and 2018, we had cash and cash equivalents of $75.7 million and $123.1 million, respectively, of which $57.9 million and $101.4 million, respectively, were held by non-U.S.
subsidiaries principally in the United Kingdom.
The decrease in cash and cash equivalents in 2019 of $47.4 million was driven by the repayment of $66.0 million of our revolving credit facility and the $82.5 million repayment of our term loan, being partly offset by our strong operating cash flows including the effective control of working capital, net of capital investment and dividend payments.
Debt
On September 26, 2019, Innospec and certain of its subsidiaries entered into a new agreement for a $250.0 million revolving credit facility until September 25, 2023 with an option to request an extension to the facility for a further year. The facility also contains an accordion feature whereby the Company may elect to increase the total available borrowings by an aggregate amount of up to $125.0 million.
On September 30, 2019 the Company repaid its pre-existing
term loan and revolving credit facility that had been amended and restated on December 14, 2016, and replaced this borrowing with the new credit facility.
As a result, refinancing costs of $1.5 million were capitalized which are being amortized over the expected life of the facility.
The new revolving credit facility contains terms which, if breached, would result in it becoming repayable on demand. It requires, among other matters, compliance with the following financial covenant ratios measured on a quarterly basis: (1) our ratio of net debt to EBITDA must not be greater than 3.0:1.0 and (2) our ratio of EBITDA to net interest must not be less than 4.0:1.0 Management has determined that the Company has not breached these covenants and does not expect to breach these covenants for the next 12 months.
The current credit facility contains restrictions which may limit our activities, and operational and financial flexibility. We may not be able to borrow if an event of default is outstanding, which includes a material adverse change to our assets, operations or financial condition. The credit facility contains a number of restrictions that limit our ability, among other things, and subject to certain limited exceptions, to incur additional indebtedness, pledge our assets as security, guarantee obligations of third parties, make investments, effect a merger or consolidation, dispose of assets, or materially change our line of business.
At December 31, 2019, we had $60.0 million of debt outstanding under the revolving credit facility and $1.5 million of obligations under finance leases relating to certain fixed assets within our Fuel Specialties and Oilfield Services segments.
At December 31, 2019, our maturity profile of long-term debt and finance leases is set out below (net of deferred finance costs capitalized of $1.4 million):
Outlook
During 2019, we have focused on consolidating and strengthening our enlarged business and on several very promising organic growth projects which will support future growth.
We have continued to deliver a strong financial performance and we believe our long-term strategy is very much in line with our expectations. The current year was successful financially and, notably, we ended the year in a net cash position on our balance sheet.
Organic growth through new product development was a key feature of 2019 and we intend this to continue to be a key focus in the coming years.
While we have had a successful year, there are issues of global trade disputes which are beyond our control and give us some cause for caution when we consider the prospects for 2020. We plan on maintaining our existing strategy to grow the business based on our twin competencies of technology and customer service and our continued investment in R&D, which will require continued investment in new product development.
The latter part of 2019 suggested that market conditions will be challenging in 2020 in all our strategic businesses. However, we feel confident that our organic growth projects and potential further acquisitions will support continued growth.
We expect the possible conclusion of revenues from our Octane Additives segment in the early part of 2020.
Contractual Commitments
The following represents contractual commitments at December 31, 2019 and the effect of those obligations on future cash flows:
Operating activities
Remediation payments represent those cash flows that the Company is currently obligated to pay in respect of environmental remediation of current and former facilities. It does not include any discretionary remediation costs that the Company may choose to incur.
Operating lease commitments relate primarily to right-of-use
assets at third party manufacturing facilities, office space, motor vehicles and various items of computer and office equipment which are expected to be renewed and replaced in the normal course of business.
Raw material purchase obligations relate to certain long-term raw material contracts which stipulate fixed or minimum quantities to be purchased; fixed, minimum or variable cost provisions; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancellable without penalty.
The estimated payments included in the table above reflect the variable interest charge on long-term debt obligations. Estimated commitment fees are also included and interest income is excluded.
Due to the uncertainty regarding the nature of tax audits, particularly those which are not currently underway, it is not meaningful to predict the outcome of obligations related to unrecognized tax benefits. Further disclosure is provided in Note 10 of the Notes to the Consolidated Financial Statements.
Investing activities
Capital commitments relate to certain capital projects that the Company has committed to undertake.
Financing activities
On September 26, 2019, Innospec and certain of its subsidiaries entered into a new agreement for a $250.0 million revolving credit facility until September 25, 2023 with an option to request an extension to the facility for a further year. The facility also contains an accordion feature whereby the Company may elect to increase the total available borrowings by an aggregate amount of up to $125.0 million.
On September 30, 2019 the Company repaid its pre-existing
term loan and revolving credit facility that had been amended and restated on December 14, 2016, and replaced this borrowing with the new credit facility.
Finance leases relate to the financing of certain fixed assets in our Fuel Specialties and Oilfield Services segments.
Environmental Matters and Plant Closures
Under certain environmental laws the Company is responsible for the remediation of hazardous substances or wastes at currently or formerly owned or operated properties.
As most of our manufacturing operations have been conducted outside the U.S., we expect that liability pertaining to the investigation and remediation of contaminated properties is likely to be determined under non-U.S.
law.
We evaluate costs for remediation, decontamination and demolition projects on a regular basis. Full provision is made for those costs to which we are committed under environmental laws amounting to $49.3 million at December 31, 2019. Remediation expenditure utilizing these provisions was $4.4 million, $3.1 million and $2.4 million in the years 2019, 2018 and 2017, respectively.
Item 7A
Item 7A
Quantitative and Qualitative Disclosures about Market Risk
The Company uses floating rate debt to finance its global operations. The Company is subject to business risks inherent in non-U.S.
activities, including political and economic uncertainty, import and export limitations, and market risk related to changes in interest rates and foreign currency exchange rates. The political and economic risks are mitigated by the stability of the countries in which the Company’s largest operations are located. Credit limits, ongoing credit evaluation and account monitoring procedures are used to minimize bad debt risk. Collateral is not generally required.
From time to time, the Company uses derivatives, including interest rate swaps, commodity swaps and foreign currency forward exchange contracts, in the normal course of business to manage market risks. The derivatives used in hedging activities are considered risk management tools and are not used for trading purposes. In addition, the Company enters into derivative instruments with a diversified group of major financial institutions in order to manage the exposure to non-performance
of such instruments. The Company’s objective in managing the exposure to changes in interest rates is to limit the impact of such changes on earnings and cash flows and to lower overall borrowing costs. The Company’s objective in managing the exposure to changes in foreign currency exchange rates is to reduce volatility on earnings and cash flows associated with such changes.
The Company offers fixed prices for some long-term sales contracts. As manufacturing and raw material costs are subject to variability the Company may use commodity swaps to hedge the cost of some raw materials thus reducing volatility on earnings and cash flows. The derivatives are considered risk management tools and are not used for trading purposes. The Company’s objective is to manage its exposure to fluctuating costs of raw materials.
Interest Rate Risk
From time to time, the Company uses interest rate swaps to manage interest rate exposure. As at December 31, 2019 the Company had cash and cash equivalents of $75.7 million, and long-term debt and finance leases of $60.1 million (including current portion). Long-term debt comprises a $250.0 million revolving credit facility available to the Company. The credit facilities carry an interest rate based on U.S. dollar LIBOR plus a margin of between 1.05% and 2.30% which is dependent on the Company’s ratio of net debt to EBITDA. Net debt and EBITDA are non-GAAP
measures of liquidity defined in the credit facility.
At December 31, 2019, $60.0 million was drawn under the revolving credit facility.
The Company previously entered into interest rate swap contracts to reduce interest rate risk on its core debt. As at December 31, 2019, there were no interest rate swaps in place with all swaps having been settled during the year. As at December 31, 2018, there were interest rate swaps with a notional value of $132.5 million in place. Interest rate swaps were in place to hedge interest rate risk on the term loan for a notional value that matched the repayment profile of the term loan.
The Company has $60.1 million long-term debt and finance leases (including the current portion) which is offset by $75.7 million cash and cash equivalents. The interest payable on long-term debt (excluding the margin) exceeds the interest receivable on positive cash balances. On a gross basis, assuming no additional interest on the cash balances and after deducting interest rate hedging, a hypothetical absolute change of 1% in U.S. base interest rates for a one-year
period would impact net income and cash flows by approximately $0.6 million before tax. On a net basis, assuming additional interest on the cash balances, a hypothetical absolute change of 1% in U.S. base interest rates for a one-year
period would impact net income and cash flows by approximately $0.2 million before tax.
The above does not consider the effect of interest or exchange rate changes on overall activity nor management action to mitigate such changes. As at December 31, 2019, Innospec did not have any interest rate swaps to mitigate the risk identified above.
Exchange Rate Risk
The Company generates an element of its revenues and incurs some operating costs in currencies other than the U.S. dollar. The reporting currency of the Company is the U.S. dollar.
The Company evaluates the functional currency of each reporting unit according to the economic environment in which it operates. Several major subsidiaries of the Company operating outside of the U.S. have the U.S. dollar as their functional currency due to the nature of the markets in which they operate. In addition, the financial position and results of operations of some of our overseas subsidiaries are reported in the relevant local currency and then translated to U.S. dollars at the applicable currency exchange rate for inclusion in our consolidated financial statements.
The primary foreign currencies in which we have exchange rate fluctuation exposure are the European Union euro, British pound sterling and Brazilian Real. Changes in exchange rates between these foreign currencies and the U.S. dollar will affect the recorded levels of our assets and liabilities, to the extent that such figures reflect the inclusion of foreign assets and liabilities which are translated into U.S. dollars for presentation in our consolidated financial statements, as well as our results of operations.
The Company’s objective in managing the exposure to foreign currency fluctuations is to reduce earnings and cash flow volatility associated with foreign currency exchange rate changes. Accordingly, the Company enters into various contracts that change in value as foreign currency exchange rates change to protect the U.S. dollar value of its existing foreign currency denominated assets, liabilities, commitments, and cash flows. The Company also uses foreign currency forward exchange contracts to offset a portion of the Company’s exposure to certain foreign currency denominated revenues so that gains and losses on these contracts offset changes in the U.S. dollar value of the related foreign currency denominated revenues. The objective of the hedging program is to reduce earnings and cash flow volatility related to changes in foreign currency exchange rates.
The trading of our Fuel Specialties, Performance Chemicals and Oilfield Services segments is inherently naturally hedged and accordingly changes in exchange rates would not be material to our earnings or financial position. The cost base of our Octane Additives reporting segment and corporate costs, however, are largely denominated in British pound sterling. A 5% strengthening in the U.S. dollar against British pound sterling would increase reported operating income by approximately $2.2 million for a one-year
period excluding the impact of any foreign currency forward exchange contracts. Where a 5% strengthening of the U.S. dollar has been used as an illustration, a 5% weakening would be expected to have the opposite effect on operating income.
Raw Material Cost Risk
We use a variety of raw materials, chemicals and energy in our manufacturing and blending processes. Many of the raw materials that we use are derived from petrochemical-based and vegetable-based feedstocks which can be subject to periods of rapid and significant cost instability. These fluctuations in cost can be caused by political instability in oil producing nations and elsewhere, or other factors influencing global supply and demand of these materials, over which we have no or little control. We use long-term contracts (generally with fixed or formula-based costs) and advance bulk purchases to help ensure availability and continuity of supply, and to manage the risk of cost increases. From time to time we enter into hedging arrangements for certain raw materials, but do not typically enter into hedging arrangements for all raw materials, chemicals or energy costs. Should the costs of raw materials, chemicals or energy increase, and should we not be able to pass on these cost increases to our customers, then operating margins and cash flows from operating activities would be adversely impacted. Should raw material costs increase significantly, then the Company’s need for working capital could similarly increase. Any of these risks could adversely impact our results of operations, financial position and cash flows.
Item 8
Item 8
Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Innospec Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheet of Innospec Inc. and its subsidiaries
(the “Company”) as of December 31, 2019,
and the related consolidated statements of income, comprehensive income, equity
and cash flows for the year then ended, including the related notes (collectively referred to as the “consolidated financial statements”).
We also have audited the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework
(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019,
and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework
(2013) issued by the COSO.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for leases in 2019.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated
financial statements and on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audit of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Plant Closure Provision
As described in Notes 2 and 12 to the consolidated financial statements, at December 31, 2019 there is a provision in place for $49.3 million relating to the Company’s legal responsibility for the remediation of hazardous substances or wastes at currently or formerly owned or operated properties, with the principal site giving rise to environmental remediation liabilities being the manufacturing site at Ellesmere Port in the United Kingdom.
The Company must comply with environmental legislation in the countries in which it operates or has operated and annually reassesses the program of work required. This included management developing estimates and assumptions relating to the cost and timing of performing the remediation work. Management used specialists to develop these estimates. Costs of future obligations are discounted to their present values using the Company’s credit-adjusted risk-free rate.
The principal considerations for our determination that performing procedures relating to the plant closure provision is a critical audit matter are that there were significant estimates and assumptions made by management over the valuation of the plant closure provision. This, in turn led to a high degree of auditor judgment, subjectivity and effort in evaluating management’s assumptions including (i) the program of work required and the costs of performing that work; (ii) the timing of performing the remediation work; and (iii) the credit-adjusted risk-free rate used to discount the future obligations. Professionals with specialized skill and knowledge were used to assist in performing procedures (i) and (ii) and evaluating the audit evidence obtained.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the valuation of the plant closure provision.
These procedures also included, among others, (i) the use of professionals with specialized skill and knowledge to assist in testing management’s process for determining the plant closure provision. This included evaluating the appropriateness of the valuation method and the reasonableness of significant assumptions, including the assessment of the program of work required, cost, and timing assumptions developed by management’s specialists; (ii) evaluating the scope, competency, and objectivity of management’s specialists based on the work they were engaged to perform; and (iii) evaluating the credit-adjusted risk-free rate applied to calculate the present value of the future obligations.
PricewaterhouseCoopers LLP (signed)
Manchester, United Kingdom
February 19, 2020
We have served as the Company’s auditor since 2019.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Innospec Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of Innospec, Inc. and subsidiaries (the Company) as of December 31, 2018, the related consolidated statements of income, comprehensive income, accumulated other comprehensive loss, cash flows and equity for the year then ended, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018, and the results of its operations and its cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
KPMG LLP
Manchester, United Kingdom
February 20, 2019
We served as the Company’s auditor from 2011 to 2019.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Innospec Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statements of income, comprehensive income, accumulated other comprehensive loss, cash flows and equity of Innospec, Inc. and subsidiaries (the Company) for the year ended December 31, 2017, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the results of the operations of the Company and its cash flows for the year ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
KPMG Audit Plc
Manchester, United Kingdom
February 15, 2018
We served as the Company’s auditor from 2011 to 2018
CONSOLIDATED STATEMENTS OF INCOME
(in millions, except share and per share data
)
The accompanying notes are an integral part of these statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions
)
The accompanying notes are an integral part of these statements.
CONSOLIDATED BALANCE SHEETS
(in millions, except share and per share data
)
The accompanying notes are an integral part of these statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions
)
Amortization of deferred finance costs of $1.0
million (2018 - $0.7
million, 2017 - $0.6
million) for the year are included in depreciation and amortization in the cash flow statement but in interest expense in the income statement. Cash payments/receipts in respect of income taxes and interest are disclosed in Note 10 and Note 11, respectively, of the Notes to the Consolidated Financial Statements.
The accompanying notes are an integral part of these statements.
CONSOLIDATED STATEMENTS OF EQUITY
(in millions
)
The accompanying notes are an integral part of these statements
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Nature of Operations
Innospec develops, manufactures, blends, markets and supplies fuel additives, oilfield chemicals, personal care products and other specialty chemicals. Our products are sold primarily to oil and gas exploration and production companies, oil refineries, personal care and home care companies, formulators of agrochemical and metal extraction preparations and other chemical and industrial companies throughout the world. Our fuel additives help improve fuel efficiency, boost engine performance and reduce harmful emissions. Our Performance Chemicals business provides effective technology-based solutions for our customers’ processes or products focused in the Personal Care, Home Care, Agrochemical and Metal Extraction markets. Our Oilfield Services business supplies drilling and production chemicals which make exploration and production more cost-efficient, and more environmentally friendly. Our Octane Additives business manufactures a fuel additive for use in automotive gasoline and provides services in respect of environmental remediation. Our principal reportable segments are Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives.
Note 2. Accounting Policies
Basis of preparation:
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States of America on a going concern basis and include all subsidiaries of the Company where the Company has a controlling financial interest. All significant intercompany accounts and balances have been eliminated upon consolidation. In accordance with GAAP in the United States of America, the results of operations of an acquired or disposed business are included or excluded from the consolidated financial statements from the date of acquisition or disposal.
Use of estimates:
The preparation of the consolidated financial statements, in accordance with GAAP in the United States of America, requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Revenue recognition:
Our revenues are primarily derived from the manufacture and sale of specialty chemicals. We recognize revenue when control of the product is transferred to our customer and for an amount that reflects the consideration we expect to collect from the customer. Control is generally transferred to the customer when title transfers (which may include physical possession by the customer), we have a right to payment from the customer, the customer has accepted the product, and the customer has assumed the risks and rewards of ownership. We have supplier managed inventory arrangements with some of our customers to facilitate on-demand
product availability. In some cases, the inventory resides at a customer site, although title has not transferred, we are not entitled to payment, and we have not invoiced for the product. We have evaluated the contract terms under these arrangements and have determined that control transfers when the customer uses the product, at which time
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
revenue is recognized. Our contracts generally include one performance obligation, which is providing specialty chemicals. The performance obligation is satisfied at a point in time when products are shipped, delivered, or consumed by the customer, depending on the underlying contracts.
While some of our customers have payment terms beyond 30 days, we do not provide extended payment terms of a year or more, nor do our contracts include a financing component. Some of our contracts include variable consideration in the form of rebates. We record rebates at the point of sale as a reduction in sales when we can reasonably estimate the amount of the rebate. The estimates are based on our best judgment at the time of sale, which includes anticipated as well as historical performance.
Taxes assessed by a governmental authority which are concurrent with sales to our customers, including sales, use, value-added, and revenue-related excise taxes, are collected by us from the customer and are not included in net sales, but are reflected in accrued liabilities until remitted to the appropriate governmental authority. When we are responsible for shipping and handling costs after title has transferred, we account for those as fulfilment costs and include them in cost of goods sold.
Components of net sales:
All amounts billed to customers relating to shipping and handling are classified as net sales. Shipping and handling costs incurred by the Company are classified as cost of goods sold.
Components of cost of goods sold:
Cost of goods sold is comprised of raw material costs including inbound freight, duty and non-recoverable
taxes, inbound handling costs associated with the receipt of raw materials, packaging materials, manufacturing costs including labor costs, maintenance and utility costs, plant and engineering overheads, amortization expense for certain other intangible assets, warehousing and outbound shipping costs and handling costs. Inventory losses and provisions and the costs of customer claims are also recognized in the cost of goods line item.
Components of selling, general and administrative expenses:
Selling expenses comprise the costs of the direct sales force, and the sales management and customer service departments required to support them. It also comprises commission charges, the costs of sales conferences and trade shows, the cost of advertising and promotions, amortization expense for certain other intangible assets, and the cost of bad and doubtful debts. General and administrative expenses comprise the cost of support functions including accounting, human resources, information technology and the cost of group functions including corporate management, finance, tax, treasury, investor relations and legal departments. Provision of management’s best estimate of legal and settlement costs for litigation in which the Company is involved is accounted for in the administrative expense line item.
Research and development expenses:
Research, development and testing costs are expensed to the income statement as incurred.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Earnings per share:
Basic earnings per share is based on the weighted average number of common shares outstanding during the period. Diluted earnings per share includes the effect of options that are dilutive and outstanding during the period.
Foreign currencies:
The Company’s policy is that foreign exchange differences arising on the translation of the balance sheets of entities that have functional currencies other than the U.S. dollar are taken to a separate equity reserve, the cumulative translation adjustment. In entities where the U.S. dollar is the functional currency no gains or losses on translation occur, and gains or losses on monetary assets relating to currencies other than the U.S. dollar are taken to the income statement in other income/(expense), net. Gains and losses on intercompany foreign currency loans which are long-term in nature, which the Company does not intend to settle in the foreseeable future, are also recorded in accumulated other comprehensive loss. Other foreign exchange gains or losses are also included in other income, net in the income statement.
Stock-based compensation plans:
The Company accounts for employee stock options and stock equivalent units under the fair value method. Stock options are fair valued at the grant date and the fair value is recognized straight-line over the vesting period of the option. Stock equivalent units are fair valued at each balance sheet date and the fair value is spread over the remaining vesting period of the unit.
Business combinations:
The acquisition method of accounting requires that we recognize the assets acquired and liabilities assumed at their acquisition date fair values. Goodwill is measured as the excess of consideration transferred over the acquisition date net fair values of the assets acquired and the liabilities assumed.
The determination of the fair values of certain assets and liabilities are usually based on significant estimates provided by management, such as forecast revenue or profit. In determining the fair value of intangible assets, an income approach is generally used and may incorporate the use of a discounted cash flow method. In applying the discounted cash flow method, the estimated future cash flows and residual values for each intangible asset are discounted to a present value using a discount rate appropriate to the business being acquired. These cash flow projections are based on management’s estimates of economic and market conditions including revenue growth rates, operating margins, capital expenditures and working capital requirements.
Cash equivalents:
Investment securities with maturities of three months or less when purchased are considered to be cash equivalents.
Trade and other accounts receivable:
The Company records trade and other accounts receivable at net realizable value and maintains allowances for customers not making required payments. The Company determines the adequacy of allowances by periodically evaluating each customer receivable considering our customer’s financial condition, credit history and current economic conditions.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Inventories:
Inventories are stated at the lower of cost (FIFO method) or market value. Cost includes materials, labor and an appropriate proportion of plant overheads. The Company accrues volume discounts where it is probable that the required volume will be attained and the amount can be reasonably estimated. The discounts are recorded as a reduction in the cost of materials based on projected purchases over the period of the agreement. Inventories are adjusted for estimated obsolescence and written down to market value based on estimates of future demand and market conditions.
Property, plant and equipment:
Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is provided over the estimated useful lives of the assets using the straight-line method and is allocated between cost of goods sold and operating expenses. The cost of additions and improvements are capitalized. Maintenance and repairs are charged to expenses as incurred. When assets are sold or retired the associated cost and accumulated depreciation are removed from the consolidated financial statements and any related gain or loss is included in earnings. The estimated useful lives of the major classes of depreciable assets are as follows:
Goodwill:
Goodwill is deemed to have an indefinite life and is subject to at least annual impairment assessments at the reporting unit level. The Company considers that its reporting units are consistent with its reportable segments. The components in each segment (including products, markets and competitors) have similar economic characteristics and the segments, therefore, reflect the lowest level at which operations and cash flows can be sufficiently distinguished, operationally and for financial reporting purposes, from the rest of the Company.
Initially we perform a qualitative assessment to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a segment is less than the carrying amount prior to performing a quantitative goodwill impairment test. The annual measurement date for impairment assessment of the goodwill relating to the Fuel Specialties, Performance Chemicals and Oilfield Services segments is December 31 each year. Factors utilized in the qualitative assessment process include macroeconomic conditions, industry and market considerations, cost factors, overall financial performance and Company specific events.
If a quantitative test is required, we assess the fair value based on projected post-tax
cash flows discounted at the Company’s weighted average cost of capital. These fair value techniques require management judgment and estimates including revenue growth rates, projected operating margins, changes in working capital and discount rates. We would develop these assumptions by considering recent financial performance and industry growth estimates.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Other intangible assets:
Other intangible assets are deemed to have finite lives and are amortized using the straight-line method over their estimated useful lives. The Company capitalizes software development costs as intangible assets, including licenses, subsequent to the establishment of technological feasibility. These assets are tested for potential impairment when events occur or circumstances change, which suggest an impairment may have occurred.
In order to facilitate testing for potential impairment the Company groups together assets at the lowest possible level for which cash flow information is available. Undiscounted future cash flows expected to result from the asset groups are compared with the carrying value of the assets and, if such cash flows are lower, an impairment loss may be recognized. The amount of the impairment loss is the difference between the fair value and the carrying value of the assets. Fair values are determined using post-tax
cash flows discounted at the Company’s weighted average cost of capital. If events occur or circumstances change it may cause a reduction in the periods over which the assets are amortized, or result in a non-cash
impairment of their carrying value. A reduction in the amortization periods would have no impact on cash flows.
The estimated useful lives of the major classes of assets are as follows:
Leases:
With an effective date of January 1, 2019 we have applied Accounting Standards Update (ASU) 2016-02,
Revision to Lease Accounting, ASC Topic 842 which replaces ASC Topic 840, Leases. ASU 2016-02
requires lessees to recognize a right-of-use
(“ROU”) asset and a lease liability for all of their leases (other than leases that meet the definition of a short-term lease).
The standard was adopted using a modified retrospective transition method, with the Company electing not to adjust comparative periods. We have taken the election not to apply the requirements to short-term leases and have taken the election not to separate related non-lease
components from lease components.
The standard had a material impact on our consolidated balance sheet as at December 31, 2019, but did not have an impact on our consolidated income statements. The most significant impact was the recognition of ROU assets and lease liabilities and the related deferred taxes thereon for operating leases, while our accounting for finance leases remained substantially unchanged. Operating lease liabilities recognized under the new standard are not considered to be debt.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
We determine if an arrangement is a lease at inception. The present value of the future lease payments for operating leases is included in operating lease ROU assets, and operating lease liabilities (current and non-current)
on our consolidated balance sheet at December 31, 2019. The carrying value of assets under finance leases is included in property, plant and equipment and finance lease liabilities (current and non-current)
on our consolidated balance sheet at December 31, 2019.
Operating lease ROU assets and operating lease liabilities are recognized based on the present value of future lease payments over the remaining lease term. Very few of our leases have renewal options or early termination break clauses, but where they do we have assessed the term of the lease based on any options being exercised only if they are reasonably certain. As most of our leases do not provide an implicit interest rate, we use our incremental borrowing rate based on the information available at point of recognition in determining the present value of future payments.
The operating lease ROU asset excludes lease incentives and initial direct costs incurred. Lease expense for lease payments is recognized on a straight-line basis over the lease term unless payments are variable per the agreement. Where we have lease payments linked to an index or inflationary rate, this rate has been used to value the asset and liability at the inception of the lease. If the payments are not linked to a specific index or inflationary rate, but can vary during the term of the agreement, they have been included at their actual value for each future period. In some circumstances the future expected payments may be dependent on other factors, for example production volumes, in which case we have used the minimum future expected payments to value the asset.
We do not recognize a ROU asset or operating lease liability for short-term leases (with a length of one year or less), and any associated cost is recognized, as incurred, through the income statement.
Deferred finance costs:
The costs relating to debt financing are capitalized, offset against long-term debt in the consolidated balance sheets and amortized using the effective interest method over the expected life of the debt financing facility. The amortization charge is included in interest expense in the income statement. See Note 11 of the Notes to the Consolidated Financial Statements.
Impairment of long-lived assets:
The Company reviews the carrying value of its long-lived assets, including buildings and equipment, whenever changes in circumstances suggest that the carrying values may be impaired. In order to facilitate this test the Company groups together assets at the lowest possible level for which cash flow information is available. Undiscounted future cash flows expected to result from the asset groups are compared with the carrying value of the asset groups and if they are lower an impairment loss may be recognized. The amount of the impairment loss is the difference between the fair value and the carrying value of the asset groups. Fair values are determined using post-tax
cash flows discounted at the Company’s weighted average cost of capital.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Derivative instruments:
From time to time,
the Company uses various derivative instruments including forward currency contracts, options, interest rate swaps and commodity swaps to manage certain exposures. These instruments are entered into under the Company’s corporate risk management policy to minimize exposure and are not for speculative trading purposes. The Company recognizes all derivatives as either current or non-current
assets or liabilities in the consolidated balance sheet and measures those instruments at fair value. Changes in the fair value of derivatives that are not designated as hedges, or do not meet the requirements for hedge accounting, are recognized in earnings. Derivatives which are designated as hedges are tested for effectiveness on a quarterly basis, and marked to market. The ineffective portion of the derivative’s change in value is recognized in earnings. The effective portion is recognized in other comprehensive income until the hedged item is recognized in earnings.
Environmental compliance and remediation:
Environmental compliance costs include ongoing maintenance, monitoring and similar costs. We recognize environmental liabilities when they are probable and the costs can be reasonably estimated, and asset retirement obligations when there is a legal obligation and the costs can be reasonably estimated. The vast majority of our plant closure provision relates to our Ellesmere Port site in the United Kingdom.
The Company must comply with environmental legislation in the countries in which it operates or has operated in and annually reassesses the program of work required. This includes estimating the credit-adjusted risk free rate and the timing and cost of performing the remediation work. Management use specialists to develop these estimates and assumptions utilizing the latest information available together with experience of recent costs. While we believe our assumptions for environmental liabilities are reasonable, they are subjective judgements and it is possible that variations in any of the assumptions will result in materially different calculations to the liabilities we have reported. Costs of future obligations are discounted to their present values using the Company’s credit-adjusted risk-free rate.
Pension plans and other post-employment benefits:
The Company recognizes the funded status of defined benefit post-retirement plans on the consolidated balance sheets and changes in the funded status in comprehensive income. The measurement date of the plan’s funded status is the same as the Company’s fiscal year-end.
The service costs are recognized as employees render the services necessary to earn the post-employment benefits. Prior service costs and credits and actuarial gains and losses are amortized over the average remaining life expectancy of the inactive participants using the corridor method.
Movements in the underlying plan asset value and Projected Benefit Obligation (“PBO”) are dependent on actual return on investments as well as our assumptions in respect of the discount rate, annual member mortality rates, future return on assets and future inflation.
Income taxes:
The Company provides for income taxes by recognizing deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
financial statement carrying amounts and the relevant tax bases of the assets and liabilities. Then the Company evaluates the need for a valuation allowance to reduce deferred tax assets to the amount more likely than not to be realized. The effect on deferred taxes of a change in tax rates is recognized in the period that includes the enactment date. The Company recognizes the tax benefit from a tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company recognizes accrued interest and penalties associated with unrecognized tax benefits as part of income taxes in our consolidated statements of income.
Note 3. Segment Reporting and Geographical Area Data
The Fuel Specialties, Performance Chemicals and Oilfield Services segments operate in markets where we actively seek growth opportunities although their ultimate customers are different. The Octane Additives segment revenues may conclude in the early part of 2020 as our one remaining refinery customer transitions to unleaded fuel.
Our Fuel Specialties segment develops, manufactures, blends, markets and supplies a range of specialty chemicals products used as additives to a wide range of fuels.
Our Performance Chemicals segment provides effective technology-based solutions for our customers’ processes or products focused in the Personal Care, Home Care, Agrochemical and Metal Extraction markets.
Our Oilfield Services segment develops and markets products to prevent loss of mud in drilling operations, chemical solutions for fracturing and stimulation operations and products for oil and gas production which aid flow assurance and asset integrity.
Our Octane Additives segment, which we believe is the world’s only producer of tetra ethyl lead (“TEL”), comprises sales of TEL for use in automotive gasoline and provides services in respect of environmental remediation.
There are no significant customers with sales greater than 10% of our net group sales in the last three financial years.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company evaluates the performance of its segments based on operating income. The following table analyzes sales and other financial information by the Company’s reportable segments:
Identifiable assets relating to the TEL operations are included within our Octane Additives segment in the table above, as they cannot be separately reported for the periods shown. Our TEL operations produce TEL for automotive gasoline, which is reported in our Octane Additives segment, and produce TEL for our AvTel product line, which is reported in our Fuel Specialties segment.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company includes within the corporate costs line item the costs of:
•
managing the Group as a company with securities listed on the NASDAQ and registered with the SEC;
•
the President/CEO’s office, group finance, group human resources, group legal and compliance counsel, and investor relations;
•
running the corporate offices in the U.S. and Europe;
•
the corporate development function since they do not relate to the current trading activities of our other reporting segments; and
•
the corporate share of the information technology, production technology, safety, health, environment, accounting and human resources departments.
The following tables analyze sales and other financial information by location:
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Sales by geographical area are reported by source, being where the transactions originated. Intercompany sales are priced using an appropriate pricing methodology and are eliminated in the consolidated financial statements.
Identifiable assets are those directly associated with the operations of the geographical area.
Goodwill has not been allocated by geographical location on the grounds that it would be impracticable to do so.
Note 4. Earnings per Share
Basic earnings per share is based on the weighted average number of common shares outstanding during the period. Diluted earnings per share includes the effect of options that are dilutive and outstanding during the period. Per share amounts are computed as follows:
In 2019, 2018 and 2017 the average number of anti-dilutive options excluded from the calculation of diluted earnings per share were 6,270, 0 and 9,422 respectively.
Note 5. Property, Plant and Equipment
Property, plant and equipment consists of the following:
Of the total net book value of equipment at December 31, 2019 $1.8 million (2018 - $3.6 million) are in respect of assets held under finance leases.
Depreciation charges were $23.6 million, $22.6 million and $21.4 million in 2019, 2018 and 2017, respectively.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 6. Leases
We have operating and finance leases for toll manufacturing facilities, warehouse storage, land, buildings, plant and equipment. Our leases have remaining lease terms of up to 11 years, some of which include options to terminate the leases within 1 year.
The components of lease expense were as follows:
Supplemental cash flow information related to leases is as follows:
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Supplemental balance sheet information related to leases is as follows:
Maturities of lease liabilities were as follows as at December 31, 2019:
As of December 31, 2019, additional operating and finance leases that have not yet commenced are $0.0 million.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Future lease payment for all non-
cancell
able operating and finance leases as of December 31, 2018 were
as follows, as accounted for under the previous lease standard, ASC 840. As such the amounts are not directly comparable to those included above.
Note 7. Goodwill
The following table analyzes goodwill movement for 2019 and 2018.
(1)
Gross cost is net of $8.7 million, $0.3
million and $289.5
million of historical accumulated amortization in respect of the Fuel Specialties, Performance Chemicals and Octane Additives reporting segments, respectively
.
The Company’s reporting units, the level at which goodwill is tested for impairment, are consistent with the reportable segments: Fuel Specialties, Performance Chemicals, Oilfield
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Services and Octane Additives. The components in each segment (including products, markets and competitors) have similar economic characteristics and the segments, therefore, reflect the lowest level at which operations and cash flows can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the Company.
The Company assesses goodwill for impairment on at least an annual basis, initially based on a qualitative assessment to determine whether it is more likely than not that the fair value of a segment is less than the carrying amount. If a potential impairment is identified then an impairment test is performed.
The Company performed its annual impairment assessment in respect of goodwill as at December 31, 2019, 2018 and 2017. Our impairment assessment concluded that there had been no
impairment of goodwill in respect of those reporting units.
We believe that where appropriate the assumptions used in our impairment assessments are reasonable, but that they are judgmental, and variations in any of the assumptions may result in materially different calculations of any potential impairment charges.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 8. Other Intangible Assets
Other intangible assets comprise the following:
Amortization expense
The aggregate of other intangible asset amortization expense was $23.0 million (excluding the impact of foreign exchange translation on the balance sheet), $26.3 million and $28.3 million in 2019, 2018 and 2017, respectively, of which $3.4 million, $3.4 million and $4.3 million, respectively, was recognized in cost of goods sold, and the remainder was recognized in selling, general and administrative expenses.
Future amortization expense is estimated to be as follows for the next five years:
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 9. Pension and Post-Employment Benefits
United Kingdom plan
The Company maintains a defined benefit pension plan (the “Plan”) covering a number of its current and former employees in the United Kingdom, although it does also have other much smaller pension arrangements in the U.S. and overseas. The Plan is closed to future service accrual but has a large number of deferred and current pensioners. The Projected Benefit Obligation (“PBO”) is based on final salary and years of credited service reduced by social security benefits according to a plan formula. Normal retirement age is 65 but provisions are made for early retirement. The Plan’s assets are invested by several investment management companies in funds holding United Kingdom and overseas equities, United Kingdom and overseas fixed interest securities, index linked securities, property unit trusts and cash or cash equivalents. The trustees’ investment policy is to seek to achieve specified objectives through investing in a suitable mixture of real and monetary assets. The trustees recognize that the returns on real assets, while expected to be greater over the long-term than those on monetary assets, are likely to be more volatile. A mixture across asset classes should nevertheless provide the level of returns required by the Plan to meet its liabilities at an acceptable level of risk for the trustees and an acceptable level of cost to the Company.
In 2019, the Company contributed $0.4 million (2018 - $1.0 million) in cash to the Plan in accordance with an agreement with the trustees.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The net service cost for the twelve months ended December 31, 2019 was $0.9 million (twelve months ended December 31, 2018 - $1.2 million and twelve months ended December 31, 2017 - $0.9 million) and has been recognized in selling, general and administrative expenses within corporate costs. The following table shows the income statement effect recognized within other income, net:
The discount rate used represents the annualized yield based on a cash flow matched methodology with reference to an AA corporate bond spot curve and having regard to the duration of the Plan’s liabilities. The inflation rate is derived using a similar cash flow matched methodology as used for the discount rate but having regard to the difference between yields on fixed interest and index linked United Kingdom government gilts. A 0.25% change in the discount rate assumption would change the PBO by approximately $24 million and the net pension credit for 2019 would change by approximately $0.1 million. A 0.25% change in the level of price inflation assumption would change the PBO by approximately $18 million and the net pension credit for 2019
by approximately $1.1
million.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Movements in PBO and fair value of Plan assets are as follows:
The current investment strategy of the Plan is to obtain an asset allocation of approximately 85% debt securities and insurance contracts and
15% equity securities and real estate
in order to achieve a more predictable return on assets.
Due to the change in the Plan’s investment strategy in 2018 the Plan’s assets no longer include index-tracking funds (December 31, 2018 - nil). The Plan holds approximately 12% (December 31, 2018 - 9%) of the Plan’s assets in debt securities issued by non-US
governments and government agencies. No more than 5% of the Plan’s assets were invested in any one individual company’s investment funds.
For the vast majority of assets, a market approach is adopted to assess the fair value of the assets, with the inputs being the quoted market prices for the actual securities held in the relevant fund.
Debt
securities
Fixed income securities are valued based on quotations received from independent pricing services or from dealers who make markets in such securities and are classified as Level 1.
Corporate debt securities are classified as Level 2 in line with the industry standard.
Equity backed securities
Common and preferred stock for which market prices are readily available at the measurement date are valued at the last reported sale price or official closing price on the primary market or exchange on which they are actively traded. Other financial derivatives are classified as level 2 and certain investments that are measured at fair value using the net asset value per share (or its equivalent) have not been categorized with a hierarchy
.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Other asset backed securities
The Company has invested in insurance contracts, known as buy-in
contracts. The value of the insurance contract is based on significant unobservable inputs including plan participant medical data, in addition to observable inputs which include expected return on assets and estimated value premium. Therefore, we have classified the contracts as Level 3 investments. Fair value estimates are provided by external parties and are subsequently reviewed and approved by management.
The Company also invests in real estate as a low risk asset backed security, classified as Level 1.
The fair values of pension assets by level of input were as follows:
(1)
Certain investments that are measured at fair value using the net asset value per share (or its equivalent) have not been categorized in the fair value table with a
hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the statement of financial position.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The reconciliation of the fair value of the Plan assets measured using significant unobservable inputs was as follows:
The projected net service cost for the year ending December 31, 2020 is $1.2
million and will be recognized in selling, general and administrative expenses.
The following net pension credit will be recognized in other income and expense:
In total, there will be a net pension credit of $5.6
million to the Innospec’s net income for the year ending December 31, 2020.
The following benefit payments are expected to be made:
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
German plan
The Company also maintains an unfunded defined benefit pension plan covering a number of its current and former employees in Germany (the “German plan”). The German plan is closed to new entrants and has no assets.
The net service cost for the German plan for the twelve months ended December 31, 2019 was $0.1
million (twelve months ended December 31, 2018 - $0.2
million and twelve months ended December 31, 2017 - $0.2
million). The following table shows the income statement effect recognized within other income and expense:
Movements in PBO of the German plan are as follows:
Other plans
As at December 31, 2019, we have post-employment obligations in our European businesses with a liability of $4.5
million (December 31, 2018 - $4.4
million).
For the year ended December 31, 2019 we have recognized an actuarial loss of $0.2 million in other comprehensive loss in relation to the Performance Chemicals pension in France.
Company contributions to defined contribution schemes during 2019 were $10.4 million (2018 - $8.6 million).
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 10. Income Taxes
A roll-forward of unrecognized tax benefits and associated accrued interest and penalties is as follows:
All of the $14.4 million of unrecognised tax benefits would impact our effective tax rate if recognised.
T
ax audits have been opened by the Italian tax authorities in respect of
Innospec Performance Chemicals Italia Srl, acquired as part of the Huntsman business, in relation to the period
2011 to
2013 inclusive. D
uring the third quarter of 2019, the Italian tax authorities opened a tax audit into 2014.
The Company believes that additional tax of approximately $
0.5 million, together with associated interest of $
0.2 million, may arise as a result of the
2011 audit. This amount was recorded at December
31,
2017. During
2018, the Company determined that additional tax of approximately $
0.9 million, together with associated interest of $
0.3 million, may arise as a result of the
2012 and
2013 audits collectively. During 2019, the company recorded additional tax of $1.0 million in relation to 2014, together with additional interest of $0.5 million relating to all years.
As any additional tax arising as a consequence of the tax audit would be reimbursed by the previous owner under the terms of the sale and purchase agreement, an unrecognized tax benefit of $3.4 million is recorded, together with an
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
indemnification asset of the same amount to reflect the fact that the final liability would be reimbursed by the previous owner.
I
n the fourth quarter of 2018, the Company recorded an uncertain tax position of $10.8
million. This portion primarily related to a potential adjustment that could arise as a consequence of the Tax Act, but for which retrospective adjustment to the filed 2017 U.S. federal income tax returns was not permissible. Additional interest
of $0.9 million has been recorded during the period ending December 31, 2019
.
Innospec Performance Chemicals France SAS and Innospec Saint-Mihiel SAS are currently subject to a corporate income tax audit in France in respect of 2016 to 2018. The Company currently anticipates that adjustments, if any, arising out of this tax audit would not result in a material change to the Company’s financial position as at December 31, 2019. Any additional tax arising as a consequence of the 2016 tax audit would be reimbursed by the previous owner under the terms of the sale and purchase agreement.
The Company and its U.S. subsidiaries remain open to examination by the IRS for years 2016 onwards. The Company’s subsidiaries in foreign tax jurisdictions are open to examination including Spain (2015 onwards), France (2016 onwards), Germany (2016 onwards), Switzerland (2017 onwards) and the United Kingdom (2018 onwards).
The sources of income before income taxes were as follows:
The components of income tax expense are summarized as follows:
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Cash payments for income taxes were $37.6 million, $35.4 million and $24.2 million during 2019, 2018 and 2017, respectively.
The effective tax rate varies from the U.S. federal statutory rate because of the factors indicated below:
The 2019 effective tax rate was negatively impacted by the change in tax estimates for 2018 compared to actual filed returns, including the impact of the final U.S. FDII regulations which were released during the first quarter of 2019.
During 2019, the Company recorded additional tax and interest arising as a consequence of the tax audit into Innospec Performance Chemicals Italia Srl. This has had a negative impact on the tax rate in 2019, although any finally determined tax liabilities would be reimbursed by the previous owner under the terms of the sale and purchase agreement.
Additional interest arising on the uncertain tax position relating to a potential adjustment that could arise as a consequence of the Tax Act has had a negative impact on the effective tax rate in 2019.
In the United Kingdom, tax legislation prohibits a tax deduction in relation to certain intercompany interest expense arising. This has also had a negative impact on the effective tax rate in 2019
.
Other items do not have a material impact on the effective tax rate.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Details of deferred tax assets and liabilities are analyzed as follows:
The Company assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the cumulative losses incurred in certain jurisdictions over the three-year period ended December 31, 2019. Such objective evidence limits the ability to consider other subjective evidence, such as our projections for future growth. On the basis of this evaluation, as of December 31, 2019, a valuation allowance of $0.8 million has been recorded to recognise only the portion of the deferred tax asset that is more likely than not to be realized. The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable income during the carry forward period are reduced or increased or if objective negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence such as our projections for growth
.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Gross net operating loss carry forwards of $33.7 million result in a deferred tax asset of $7.3 million, net of valuation allowances
. The net operating loss carry forwards arose in the U.S. and in five
of the Company’s foreign subsidiaries. Net operating loss carry forwards of $3.9 million arose from state tax losses in prior periods in certain of the Company’s U.S. subsidiaries. It is expected that sufficient taxable profits will be generated in the U.S. against which the state net operating loss carry forwards of $3.8 million can be relieved before their expiration in the period
2031 to 2038. The remaining $0.1 million of the U.S. net operating losses can be carried forward indefinitely without expiration. Net operating loss carry forwards of $29.8 million arose in five of the Company’s foreign subsidiaries. It is expected that sufficient taxable profits will be generated against which $26.4 million of these net operating loss carry forwards can be relieved. These losses can be carried forward indefinitely without expiration.
Note 11. Long-Term Debt
Long-term debt consists of the following:
On September 26, 2019, Innospec and certain of its subsidiaries entered into a new agreement for a $250.0 million revolving credit facility until September 25, 2023
with an option to request an extension to the facility for a further year. The facility also contains an accordion feature whereby the Company may elect to increase the total available borrowings by an aggregate amount of up to $125.0 million.
On September 30, 2019 the Company repaid its pre-existing
term loan and revolving credit facility that had been amended and restated on December 14, 2016, and replaced this borrowing with the new credit facility.
As a result, refinancing costs of $1.5 million were capitalized which are being amortized over the expected life of the facility.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Amortization expense was $1.0 million, $0.7 million and $0.6 million in 2019, 2018 and 2017, respectively. The charge is included in interest expense, see Note 2 of the Notes to the Consolidated Financial Statements.
The obligations of the Company under the credit facility are secured obligations and guaranteed by certain subsidiaries of the Company. Amounts available under the revolving facility may be borrowed in U.S. dollars, Euros, British pounds and other freely convertible currencies.
The Company’s credit facility contains
restrictive clauses which may constrain our activities and limit our operational and financial flexibility. The facility obliges the lenders to comply with a request for utilization of finance unless there is an event of default outstanding. Events of default
are defined in the credit facility and include a material adverse change to our assets, operations or financial condition. The facility contains a number of restrictions that limit our ability,
amongst other things, and subject to certain limited exceptions, to incur additional indebtedness, pledge our assets as security, guarantee obligations of third parties, make investments, undergo a merger or consolidation, dispose of assets, or materially change our line of business.
In addition, the credit facility contains terms which, if breached, would result in it becoming repayable on demand. It requires, among other matters, compliance with the following financial covenant ratios measured on a quarterly basis: (1) the ratio of net debt to EBITDA shall not be greater than 3.0:1 and (2) the ratio of EBITDA to net interest shall not be less than 4.0:1. Management has determined that the Company has not breached these covenants throughout the period to December 31, 2019 and does not expect to breach these covenants for the next 12 months.
The weighted average rate of interest on borrowings was 3.14% at December 31, 2019 and 3.32% at December 31, 2018. Payments of interest on long-term debt were $4.8 million, $6.5 million and $7.2 million in 2019, 2018 and 2017, respectively.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The net cash outflows in respect of refinancing costs were $1.5 million, $0.0 million and $0.0 million in 2019, 2018 and 2017, respectively.
Note 12. Plant Closure Provisions
The Company has continuing plans to close some of its manufacturing facilities at sites around the world as and when those operations are expected to be decommissioned. The liability for estimated closure costs of lnnospec’s manufacturing facilities includes costs for decontamination and environmental remediation activities (“remediation”).
As a result, the principal site giving rise to remediation liabilities is the manufacturing site at Ellesmere Port in the United Kingdom, which management believes is the last ongoing manufacturer of TEL. There are also remediation liabilities on a much smaller scale in respect of our other manufacturing sites in the U.S. and Europe.
Movements in the provisions are summarized as follows:
Amounts due within one year refer to provisions where expenditure is expected to arise within one year of the balance sheet date. Remediation costs are recognized in cost of goods sold.
The provisions for remediation represent the Company’s liability for environmental liabilities and asset retirement obligations. The charge for the period in 2019 represents the accretion expense recognized of $4.3 million and a further $0.1 million primarily in respect of changes in the expected cost and scope of future remediation activities.
In 2017, we recognized $2.8 million of asset retirement obligations, in relation to the acquisition of our European Performance Chemicals business, as an increase in the value of the tangible assets acquired. This is being depreciated over the remaining useful economic life of those assets.
We recognize environmental liabilities when they are probable and costs can be reasonably estimated, and asset retirement obligations when there is a legal obligation and costs can be reasonably estimated. The Company has to anticipate the program of work required and the
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
associated future expected costs, and comply with environmental legislation in the countries in which it operates or has operated in.
Remediation expenditure utilized provisions of $4.4 million, $3.1 million and $2.4 million in 2019, 2018
and 2017, respectively.
Note 13. Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes a mid-market
pricing convention for valuing the majority of its assets and liabilities measured and reported at fair value. The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. The Company primarily applies the market approach for recurring fair value measurements and endeavors to utilize the best available information. Accordingly, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The Company is able to classify fair value balances based on the observability of those inputs. The Company gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy Levels. In 2018, the Company evaluated the fair value hierarchy levels assigned to its assets and liabilities, and concluded that there should be no transfers into or out of Levels 1, 2 and 3.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table presents the carrying amount and fair values of the Company’s assets and liabilities measured on a recurring basis:
The following methods and assumptions were used to estimate the fair values of financial instruments:
Cash and cash equivalents:
The carrying amount approximates fair value because of the short-term maturities of such instruments.
Long-term debt and finance leases:
Long-term debt principally comprises the revolving credit facility, which is shown net of deferred finance costs that have been capitalized. The fair value of long-term debt approximates to the carrying value. Finance leases relate to certain fixed assets in our Fuel Specialties and Oilfield Services segments. The carrying amount of long-term debt and finance leases approximates to the fair value.
Derivatives:
The fair value of derivatives relating to foreign currency forward exchange contracts and interest rate swaps are derived from current settlement prices and comparable contracts using current assumptions. Foreign currency forward exchange contracts primarily relate to contracts entered into to hedge future known transactions or hedge balance sheet net
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
cash positions. The movements in the carrying amounts and fair values of these contracts are largely due to changes in exchange rates against the U.S. dollar. Interest rate swaps in the prior year related to contracts taken out to hedge interest rate risk on a portion of our long-term debt.
Stock equivalent units:
The fair values of stock equivalent units are calculated at each balance sheet date using either the Black-Scholes or Monte Carlo method.
Note 14. Derivative Instruments and Risk Management
The Company has limited involvement with derivative instruments and does not trade them. The Company does use derivatives to manage certain interest rate, foreign currency exchange rate and raw material cost exposures, as the need arises.
The Company previously
entered
into interest rate swap contracts to reduce interest rate risk on its core debt. As at December 31, 2019, there were no interest rate swaps in place with all swaps having been settled during the year. As at Decem
ber
31, 2018, there were
interest rate swaps with a notional value of $132.5 million in place
. Interest rate swaps were
in place to hedge interest rate risk on the term loan for a notional value that matched
the repayment profile of the term loan. These interest rate swaps were
designated as hedging instruments, and their impact on other comprehensive loss for 2019 was a loss
of $1.9 million (2018 - gain $0.4 million).
The Company enters into various foreign currency forward exchange contracts to minimize currency exchange rate exposure from expected future cash flows. As at December 31, 2019, foreign currency forward exchange contracts with a notional value of $108.9 million were in place (December 31, 2018 $108.7 million), with maturity dates of up to one year
from the date of inception. These foreign currency forward exchange contracts have not been designated as hedging instruments, and their impact on the income statement for 2019 was a gain
of $1.5 million (2018 - loss $1.8 million).
As at December 31, 2019 and December 31, 2018 the Company did not hold any raw material derivatives.
The Company sells a range of specialty chemicals to major oil refineries and chemical companies throughout the world. Credit limits, ongoing credit evaluation and account monitoring procedures are intended to minimize bad debt risk. Collateral is not generally required.
Note 15. Commitments and Contingencies
Environmental remediation obligations
Commitments in respect of environmental remediation obligations are disclosed in Note 12 of the Notes to the Consolidated Financial Statements.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Capital commitments
The estimated additional cost to complete work in progress at December 31, 2019 is $4.0 million (2018 - $6.0 million).
Contingencies
Legal matters
While we are involved from time to time in claims and legal proceedings that result from, and are incidental to, the conduct of our business including business and commercial litigation, employee and product liability claims, there are no material pending legal proceedings to which the Company or any of its subsidiaries is a party, or of which any of their property is subject. It is possible however, that an adverse resolution of an unexpectedly large number of such individual items could in the aggregate have a material adverse effect on results of operations for a particular year or quarter.
Guarantees
The Company and certain of the Company’s consolidated subsidiaries are contingently liable for certain obligations of affiliated companies primarily in the form of guarantees of debt and performance under contracts entered into as a normal business practice. This includes guarantees of non-U.S.
excise taxes and customs duties. As at December 31, 2019, such guarantees which are not recognized as liabilities in the consolidated financial statements amounted to $4.7 million (December 31, 2018 - $5.0 million).
The remaining terms of the fixed maturity guarantees vary from 1 month to 4 years, with some further guarantees having no fixed expiry date.
Under the terms of the guarantee arrangements, generally the Company would be required to perform should the affiliated company fail to fulfill its obligations under the arrangements. In some cases, the guarantee arrangements have recourse provisions that would enable the Company to recover any payments made under the terms of the guarantees from securities held of the guaranteed parties’ assets.
The Company and its affiliates have numerous long-term sales and purchase commitments in their various business activities, which are expected to be fulfilled with no adverse consequences material to the Company.
Note 16. Stockholders’ Equity
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
At December 31, 2019, the Company had authorized common stock of 40,000,000
shares (2018
-
40,000,000
).
Note 17. Stock-Based Compensation Plans
Stock option plans
The Company has two
stock option plans, the Omnibus Long-Term Incentive Plan and the ShareS
ave Plan 2008 under which it currently grants awards. The stock options have vesting periods ranging from 24 months to 5 years and in all cases stock options granted expire within 10 years of the date of grant. All grants are at the sole discretion of the Compensation Committee of the Board of Directors. Grants may be priced at market value or at a premium or discount. The aggregate number of shares of common stock reserved for issuance which can be granted under the plans is 2,550,000.
The fair value of stock options is measured on the grant date using either the Black-Scholes model, or in cases where performance criteria are dependent upon external factors such as the Company’s stock price, using a Monte Carlo model. The following weighted average assumptions were used to determine the grant-date fair value of options:
The following table summarizes the transactions of the Company’s stock option plans for the year ended December 31, 2019:
At December 31, 2019, there were 41,525 stock options that were exercisable, 8,530 had performance conditions attached.
The Company’s policy is to issue shares from treasury stock to holders of stock options who exercise those options, but if sufficient treasury stock is not available, the Company will issue previously unissued shares of stock to holders of stock options who exercise options.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The stock option compensation cost for 2019, 2018 and 2017 was $6.6 million, $4.9 million and $4.2 million, respectively. The total intrinsic value of options exercised in 2019, 2018 and 2017 was $3.5 million, $3.2 million and $2.9 million, respectively.
The total compensation cost related to non-vested
stock options not yet recognized at December 31, 2019 was $8.6 million and this cost is expected to be recognized over the weighted-average period of 1.76 years.
In
2019, the Company recorded a current tax benefit of $
1.5 million in respect of stock option compensation
(2018 - $
1.2 million). This amount is inclusive of excess tax benefits.
Forfeits are accounted for as an adjustment to the charge in the period in which the forfeits occur.
Stock equivalent units
The Company awards Stock Equivalent Units (“SEUs”) from time to time as a long-term performance incentive. SEUs are cash settled equity instruments conditional on certain performance criteria and linked to the Innospec Inc. share price. SEUs have vesting periods ranging from 11 months to 4 years and in all cases SEUs granted expire within 10 years of the date of grant. Grants may be priced at market value or at a premium or discount. There is no limit to the number of SEUs that can be granted. As at December 31, 2019 the liability for SEUs of $24.6 million is included
in accrued liabilities in the consolidated balance sheets until they are cash settled.
The fair value of SEUs is measured at the balance sheet date using either the Black-Scholes model, or in cases where performance criteria are dependent upon external factors such as the Company’s stock price, using a Monte Carlo model. The following assumptions were used to determine the fair value of SEUs at the balance sheet dates:
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table summarizes the transactions of the Company’s SEUs for the year ended December 31, 2019:
At December 31, 2019, there were 31,649 SEUs that were exercisable, 28,881 had performance conditions attached.
The charges for SEUs are spread over the life of the award subject to a revaluation to fair value each quarter. The revaluation may result in a charge or a credit to the income statement in the quarter dependent upon our share price and other performance criteria.
The SEU compensation cost for 2019, 2018 and 2017 was $20.1 million, $5.7 million and $6.6 million, respectively. The total intrinsic value of SEUs exercised in 2019, 2018 and 2017 was $7.3 million, $2.7 million and $1.7 million, respectively.
The weighted-average remaining vesting period of non-vested
SEUs is 1.88 years.
Forfeits are accounted for as an adjustment to the charge in the period in which the forfeits occur.
Note 18. Reclassifications out of Accumulated Other Comprehensive Loss
Reclassifications out of accumulated other comprehensive loss for 2019 were:
(1)
These items are included in the computation of net periodic pension cost. See Note 9 of the Notes to the Consolidated Financial Statements for additional information.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Changes in accumulated other comprehensive loss for 2019, net of tax, were:
Note 19. Recently Issued Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2016-13,
Financial Instruments - Credit Losses (ASC Topic 326). This replaces the incurred loss impairment methodology under current GAAP with a methodology that reflects
expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We will be required to use a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. Credit losses relating to available-for-sale
debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be effective for the Company beginning January 1, 2020. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We have
evaluated
the impact of this standard on our consolidated financial statements, including accounting policies, processes and systems. We expec
t the impact on the financial statements of adopting this standard to be minimal.
Note 20. Related Party Transactions
Mr. Robert I. Paller has been a non-executive
director of the Company since November 1, 2009. The Company has retained and continues to retain Smith, Gambrell & Russell, LLP (“SGR”), a law firm with which Mr. Paller holds a position. In 2019, 2018 and 2017 the Company incurred fees payable to SGR of $0.5 million, $0.3 million and $0.4 million, respectively. As at December 31, 2019 and at December 31, 2018, the Company did no
t have any amounts outstanding due to SGR.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Mr. David F. Landless has been a non-executive
director of the Company since January 1, 2016 and is a non-executive
director of Ausurus Group Limited which owns European
Metal
Recycling Limited (“EMR”). The Company has sold scrap metal to EMR in
2019 for a value of $
0.4 million
(2018
- $0.3 million; 2017
- $0.0 million)
. A tendering process is operated periodically to select the best buyer for the sale of scrap metal by the Company. As at December
31,
2019 EMR owed $
0.0 million (December 31, 2018 - $
0.1 million).
Note 21. Subsequent Events
The Company has evaluated subsequent events through the date that the consolidated financial statements were issued, and has concluded that no additional disclosures are required in relation to events subsequent to the balance sheet date.
Item 9
Item 9
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A
Item 9A
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Based on an evaluation carried out as of the end of the period covered by this report, under the supervision and with the participation of our management, our Chief Executive Officer and our Chief Financial Officer concluded that the Company’s “disclosure controls and procedures” (as defined in Rules 13a-15(e)
and 15d-15(e)
of the Securities Exchange Act of 1934) were effective as of December 31, 2019.
Management’s Report on Internal Control Over Financial Reporting
Our management, including the Chief Executive Officer and the Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting (within the meaning of Rule 13a-15(f)
under the Securities Exchange Act of 1934). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
Internal control over financial reporting includes those policies and procedures that:
• pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
• provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and that our receipts and expenditures are being made only in accordance with authorization of our management and directors; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the consolidated financial statements.
Due to its inherent limitations, management does not believe that internal control over financial reporting will prevent or detect all errors or fraud. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Based on criteria in Internal Control - Integrated Framework (2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission the evaluation of our management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company did maintain effective internal control over financial reporting as of December 31, 2019.
Our independent registered public accounting firm PricewaterhouseCoopers LLP, has audited our consolidated financial statements and the effectiveness of our internal control over financial reporting as of December 31, 2019. Their report is included in Item 8 of this Annual Report on Form 10-K.
Changes in Internal Controls over Financial Reporting
As disclosed under Item 4 Controls and Procedures in our Quarterly Report on Form 10-Q
for the period ended June 30, 2019 management identified a material weakness in internal control over financial reporting relating to a network security incident that prevented access to certain information technology systems and data within our network. Management designed and maintained new controls and procedures to improve the IT infrastructure. Therefore, as of December 31, 2019 management has concluded that these controls are operating effectively and the material weakness remediated.
The Company is continuously seeking to improve the efficiency and effectiveness of its operations and of its internal controls. This is intended to result in refinements to processes throughout the Company.
There were no changes to our internal control over financial reporting which were identified in connection with the evaluation required by paragraph (d) of Rules 13a-15
and 15d-15
under the Securities Exchange Act of 1934, have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting, other than those to remediate the aforementioned material weakness in the Company’s IT infrastructure, that occurred during our second fiscal quarter.
Item 9B
Item 9B
Other Information
None.
PART III
Item 10
Item 10
Directors, Executive Officers and Corporate Governance
The information set forth under the headings “Re-Election
of Two Class I Directors”, “Information about the Board of Directors,” “Information about the Executive Officers” and “Delinquent Section 16(a) Reports” in the Proxy Statement for the Annual Meeting of Stockholders to be held on May 6, 2020 (“the Proxy Statement”) is incorporated herein by reference.
The Board of Directors has adopted a Code of Conduct that applies to the Company’s directors, officers and employees, including the Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer. Any stockholder who would like to receive a copy of our Code of Conduct, our Corporate Governance Guidelines or any charters of our Board’s committees may obtain them without charge by writing to the General Counsel and Chief Compliance Officer, Innospec Inc., 8310 South Valley Highway, Suite 350, Englewood, Colorado, 80112, e-mail
investor@innospecinc.com
. These and other documents can also be accessed via the Company’s web site, www.innospecinc.com
.
The Company intends to disclose on its web site www.innospecinc.com
any amendments to, or waivers from, its’ Code of Conduct that are required to be publicly disclosed pursuant to the rules of the SEC or Nasdaq.
Information regarding the Audit Committee of the Board of Directors, including membership and requisite financial expertise, set forth under the headings “Corporate Governance - Board Committees - Audit Committee” in the Proxy Statement is incorporated herein by reference.
Information regarding the procedures by which stockholders may recommend nominees to the Board of Directors set forth under the heading “Corporate Governance - Board Committees - Nominating and Governance Committee” in the 2020 Proxy Statement is incorporated herein by reference.
Item 11
Item 11
Executive Compensation
The information set forth under the headings “Executive Compensation,” “Corporate Governance - Board Committees - Compensation Committee - Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in the Proxy Statement is incorporated herein by reference.
Item 12
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information set forth under the heading “Information About our Common Stock Ownership” in the Proxy Statement is incorporated herein by reference.
Shares Authorized for Issuance Under Equity Compensation Plans
The information set forth in the table under the heading “Equity Compensation Plans” in the Proxy Statement is incorporated herein by reference.
Item 13
Item 13
Certain Relationships and Related Transactions, and Director Independence
The information set forth under the headings “Related Person Transactions and Relationships”, “Related Person Transactions Approval Policy” and “Corporate Governance - Director Independence” in the Proxy Statement is incorporated herein by reference.
Item 14
Item 14
Principal Accountant Fees and Services
Information regarding fees and services related to the Company’s independent registered public accounting firm, PricewaterhouseCoopers LLP and KPMG LLP, is provided under the heading “Principal Accountant Fees and Services” in the Proxy Statement and is incorporated herein by reference. Information regarding the Audit Committee’s pre-approval
policies and procedures is provided under the heading “Audit Committee Pre-approval
Policies and Procedures” in the Proxy Statement and is incorporated herein by reference.
PART IV
Item 15
Item 15
Exhibits and Financial Statement Schedules
10.4
Contract of Employment, Mr. Patrick Williams, dated October 11, 2005, (Incorporated by reference to Exhibit 99.1 of the Company’s Form 8-K on October 12, 2005) and Executive Service Agreement dated April 2, 2009. (Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K on April 3, 2009). *
10.5
Contract of Employment, Mr. Ian Cleminson, dated June 30, 2006 (Incorporated by reference to Exhibit 99.2 of the Company’s Form 8-K on June 30, 2006). *
10.6
Innospec Inc. Performance Related Stock Option Plan 2008 (Incorporated by reference to Appendix A of the Company’s Proxy Statement on April 1, 2011). *
10.7
Innospec Inc. Company Share Option Plan 2008 (Incorporated by reference to Appendix B of the Company’s Proxy Statement on April 1, 2011). *
10.8
Innospec Inc. Non-Employee Directors’ Stock Option Plan 2008 (Incorporated by reference to Appendix C of the Company’s Proxy Statement on April 1, 2011). *
10.9
Innospec Inc. ShareSave Plan 2008 (Incorporated by reference to Appendix D of the Company’s Proxy Statement on March 31, 2008). *
10.10
Innospec Inc. Executive Co-Investment Stock Plan 2004, as amended by the First Amendment 2006 (Incorporated by reference to Exhibit 10.10 of the Company’s Form 10-K on February 17, 2012). *
10.11
Contract of Employment, Mr. David E. Williams, dated September 17, 2009 (Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K on September 14, 2009). *
10.12
Form of Indemnification Agreement for individual who is an officer (Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on February 27, 2014).
10.13
Form of Indemnification Agreement for individual who is a director (Incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed on February 27, 2014).
10.14
Form of Indemnification Agreement for individual who is an officer and director (Incorporated by reference to Exhibit 10.3 of the Company’s Form 8-K filed on February 27, 2014).
10.15
Employment contract for Brian Watt (Incorporated by Reference to Exhibit 10.4 of the Company’s Form 10-Q filed on May 7, 2014). *
10.16
Innospec Inc. 2014 Long-Term Incentive Plan (Incorporated by Reference to Exhibit 10.5 of the Company’s Form 10-Q filed on May 7, 2014). *
10.17
Executive Service Letter to Mr. Philip J. Boon dated October 15, 2015 (Incorporated by reference to Exhibit 10.24 of the Company’s Form 10-K on February 17, 2016). *
10.18
$250,000,000 Multicurrency Revolving Facility Agreement with various lenders dated September 26, 2019 (Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K on September 30, 2019).
10.19
Innospec Inc. 2018 Omnibus Long-Term Incentive Plan (Incorporated by reference to Exhibit 10.1 to the Registrant’s Form 8-K filed May 10, 2018).
10.20
Innospec Inc. ShareSave Plan 2008 (as amended and restated) (Incorporated by reference to Exhibit 10.2 to the Registrant’s Form 8-K filed May 10, 2018)
Letter regarding change in certifying accountant dated April 10, 2019 (Incorporated by reference to Exhibit 16.1 of the Company’s Form 8-K filed April 11, 2019).
21.1
Principal Subsidiaries of the Registrant (filed herewith).
23.1
Consent of Independent Registered Public Accounting Firm, PricewaterhouseCoopers LLP (filed herewith).
23.2
Consent of Independent Registered Public Accounting Firm, KPMG LLP (filed herewith).
23.3
Consent of Independent Registered Public Accounting Firm, KPMG Audit Plc (filed herewith).
31.1
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
31.2
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.1
Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.2
Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
XBRL Instance Document and Related Items.
Cover Page Interactive Data File - The cover page XBRL tags are embedded within the inline XBRL document.
* Denotes a management contract or compensatory plan.
Item 16
Form 10-K
Summary
Not Applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INNOSPEC INC.
By:
/s/ PATRICK S. WILLIAMS
(Registrant)
Patrick S. Williams
Date:
President and Chief Executive Officer
February 19, 2020
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of February 19, 2020:
/s/ MILTON C. BLACKMORE
Milton C. Blackmore
Chairman and Director
/s/ PATRICK S. WILLIAMS
Patrick S. Williams
President and Chief Executive Officer (Principal Executive Officer); Director
/s/ IAN P. CLEMINSON
Ian P. Cleminson
Executive Vice President and Chief Financial Officer
/s/ CHRISTOPHER J. PARSONS
Christopher J. Parsons
Head of Group Finance (Principal Accounting Officer)
/s/ HUGH G. C. ALDOUS
Hugh G. C. Aldous
Director
/s/ DAVID F. LANDLESS
David F. Landless
Director
/s/ LAWRENCE J. PADFIELD
Lawrence J. Padfield
Director
/s/ ROBERT I. PALLER
Robert I. Paller
Director
/s/ CLAUDIA POCCIA
Claudia Poccia
Director
/s/ JOACHIM ROESER
Joachim Roeser
Director