Item 7. Management’s Discussion and Analysis
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
For much of 2020, customer demand was adversely impacted by the COVID-19
pandemic and the unprecedented collapse in demand for crude oil. The low point of the year for the decline in customer demand was the second quarter and all of our businesses have been showing some recovery since that time, although they have not yet returned to pre-pandemic
levels.
We also successfully navigated a number of world trade disputes which threatened to have a negative impact on our business.
Performance Chemicals continued its organic growth driven by new product development and the development of new customers in the personal care, home care, agrochemical and metal extraction markets.
Both Fuel Specialties and Oilfield Services suffered from the dramatic drop in demand. In Oilfield Services, we responded by making substantial cuts in costs to reflect the reduced customer activity levels. We believe that both markets were showing signs of good recovery by the end of the year.
The Octane Additives business concluded its trading with its last customer for motor gasoline during the year, as its sole customer completed their 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. Ellesmere Port in the United Kingdom is our principal site giving rise to environmental remediation liabilities associated with the production of TEL. 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, 2020 amounted to $58.5 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
28
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., the U.K., the E.U. 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 the liabilities recorded in our financial statements, 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 11 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 Note10 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 United Kingdom’s 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
29
discount rate assumption would change the PBO by approximately $26 million while the net pension credit for 2020 would change by approximately $0.4 million. A 0.25% change in the level of price inflation assumption would change the PBO by approximately $19 million and the net pension credit for 2021 would change by approximately $1.2 million.
Further information is provided in Note 10 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, 2020 we had $371.2 million of goodwill relating to our Fuel Specialties, Performance Chemicals and Oilfield Services segments. Due to the triggering events of the COVID-19
pandemic and the reduction in oil prices and their impact on our business, we performed a step one impairment review at June 30, 2020. The impairment assessment indicated the fair values substantially exceeded the carrying values for all operating segments. Despite this, due to a significant downturn in one of the entities, we performed a further assessment of the intangible assets of that entity, which resulted in an impairment of $19.8 million at June 30, 2020.
Property, Plant and Equipment and Other Intangible Assets (Net of Depreciation and Amortization, respectively)
As at December 31, 2020 we had $210.8 million of property, plant and equipment and $75.3 million of other intangible assets (net of depreciation and amortization, respectively),
30
that are discussed in Notes 6 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.
Impact of COVID-19
Pandemic and Current Economic Environment
The Company’s results have been adversely impacted in 2020, due to the COVID-19
pandemic and the global economic environment.
Fuel Specialties have been impacted by reduced demand stemming from the reduction in freight transport and passenger miles and the widespread grounding of aircraft for a large part of the year. We have seen some improvement in the fourth quarter as travel has begun to increase, but demand has not returned to the pre-COVID-19
levels. We expect demand will continue to improve in 2021, to the extent global economic activity recovers, subject to the continuation of the current lockdowns in Europe in particular and the potential for future lockdowns or restrictions around the world related to the spread of new COVID variants.
Performance Chemicals have experienced little overall impact from the pandemic as increased demand for certain products linked to health, hygiene and cleaning outweighed some lost revenues linked to the short-term shutdown of some of our customers manufacturing facilities.
Oilfield Services have been heavily impacted by the reduction in oil exploration and production as the wider industry reacts to the reduction in demand and low oil price. We have seen some improvement in the second half of the year from increasing demand and the benefit from the reduction in headcount that occurred in the second quarter. We do not know how long this downturn will last and the rate of recovery will depend heavily on the rate and extent to which the government restrictions on movement are lifted and not re-imposed.
Our manufacturing facilities have continued to operate with only some minor interruption, and we expect them to continue to do so. We have implemented flexible working, including working from home for our employees where possible, in line with advice and rules in each of the jurisdictions in which we operate. Additional costs have been incurred to ensure our manufacturing and administrative facilities are COVID safe for our employees. While these costs have not been significant to date there may be increased costs in the future, if further safety restrictions are required. Raw material sourcing has not been significantly impacted and we do not expect that to change over the remainder of the year. Logistics are operating with some delays but our products are currently being delivered to our customers.
We believe that our financial position remains strong. We expect to have sufficient access to capital if needed, including our $250 million revolving credit facility we entered into in September 2019, and we do not anticipate any issues with meeting the covenants for our debt agreements. We have extended this facility by a further twelve months until September 2024, during the third quarter of 2020. Our major capital projects are continuing to progress as planned.
31
As we operate in the chemical industry, we continue to be focused on protecting the health and safety of our employees and have procedures in place at each of our operating facilities to help ensure their well-being.
We do not know how long the pandemic and current economic environment will continue and while we have made estimates as to potential impacts on our financial position and operations, the ultimate impact on our business will depend on many factors which are very difficult to predict with certainty and substantially beyond our control.
RESULTS OF OPERATIONS
The following table provides operating income by reporting segment:
(in millions)
2020
2019
2018
Net sales:
Fuel Specialties
$
512.7
$
583.7
$
574.5
Performance Chemicals
425.4
428.7
468.1
Oilfield Services
255.0
479.9
400.6
Octane Additives
0.0
21.0
33.7
$
1.193.1
$
1,513.3
$
1,476.9
Gross profit:
Fuel Specialties
$
160.3
$
204.5
$
195.0
Performance Chemicals
103.8
100.1
97.5
Oilfield Services
80.8
159.9
130.4
Octane Additives
(2.2
)
1.7
12.1
$
342.7
$
466.2
$
435.0
Operating income:
Fuel Specialties
$
84.5
$
116.6
$
116.3
Performance Chemicals
54.8
48.7
44.7
Oilfield Services
(9.5
)
39.7
22.1
Octane Additives
(2.8
)
(0.7
)
9.9
Corporate costs
(52.2
)
(54.4
)
(52.4
)
Restructuring charge
(21.3
)
0.0
(7.1
)
Impairment of intangible assets
(19.8
)
0.0
0.0
Total operating income
$
33.7
$
149.9
$
133.5
Other income, net
$
7.8
$
5.3
$
5.0
Interest expense, net
(1.8
)
(4.8
)
(6.9
)
Income before income taxes
39.7
150.4
131.6
Income taxes
(11.0
)
(38.2
)
(46.6
)
Net income
$
28.7
$
112.2
$
85.0
32
Results of Operations – Fiscal 2020 compared to Fiscal 2019:
(in millions, except ratios)
2020
2019
Change
Net sales:
Fuel Specialties
$
512.7
$
583.7
$
(71.0
)
-12
%
Performance Chemicals
425.4
428.7
(3.3
)
-1
%
Oilfield Services
255.0
479.9
(224.9
)
-47
%
Octane Additives
0.0
21.0
(21.0
)
-100
%
$
1,193.1
$
1,513.3
$
(320.2
)
-21
%
Gross profit:
Fuel Specialties
$
160.3
$
204.5
(44.2
)
-22
%
Performance Chemicals
103.8
100.1
3.7
+4
%
Oilfield Services
80.8
159.9
(79.1
)
-49
%
Octane Additives
(2.2
)
1.7
(3.9
)
-229
%
$
342.7
$
466.2
(123.5
)
-26
%
Gross margin (%):
Fuel Specialties
31.3
35.0
-3.7
Performance Chemicals
24.4
23.3
1.1
Oilfield Services
31.7
33.3
-1.6
Octane Additives
0.0
8.1
-8.1
Aggregate
28.7
30.8
-2.1
Operating expenses:
Fuel Specialties
$
(75.8
)
$
(87.9
)
$
12.1
-14
%
Performance Chemicals
(49.0
)
(51.4
)
2.4
-5
%
Oilfield Services
(90.3
)
(120.2
)
29.9
-25
%
Octane Additives
(0.6
)
(2.4
)
1.8
-75
%
Corporate costs
(52.2
)
(54.4
)
2.2
-4
%
Restructuring charge
(21.3
)
0.0
(21.3
)
n/a
Impairment of intangible assets
(19.8
)
0.0
(19.8
)
n/a
$
(309.0
)
$
(316.3
)
$
7.3
-2
%
Financial information with respect to our domestic and foreign operations is contained in Note 3 of the Notes to the Consolidated Financial Statements.
33
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:
Change (%)
Americas
EMEA
ASPAC
AvTel
Total
Volume
-7
-8
-11
+11
-7
Price and product mix
-1
-7
-10
-19
-6
Exchange rates
0
+2
0
0
+1
-8
-13
-21
-8
-12
Volumes in all our regions have suffered from the adverse impact of the COVID-19
pandemic, which has reduced the global demand for fuel additive products. During the second half of 2020, we have seen customer demand recovering steadily as lockdowns in countries around the world have been eased. However, the reintroduction of lockdowns for European countries in January 2021 could slow the return of customer demand to the pre-pandemic
level. Price and product mix in all our regions was adverse due to lower sales of our higher margin products. AvTel volumes were higher than the prior year due to variations in the demand from customers, being offset by an adverse price and product mix. EMEA benefitted from favorable exchange rate movements year over year, due to a strengthening of the British pound sterling and the European Union euro against the U.S. dollar.
Gross margin:
the year over year decrease of 3.7 percentage points was driven by the impact of the COVID-19
pandemic reducing demand for our higher margin products, together with adverse raw material costs and higher provisions for slow moving inventory.
Operating expenses:
the year over year decrease of $12.1 million was due to cost savings as a result of the COVID-19
pandemic, including lower travel and entertainment costs, together with lower personnel related performance-based remuneration due to a decrease in share-based compensation accruals linked to the Innospec share price.
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:
Change (%)
Americas
EMEA
ASPAC
Total
Volume
+13
-1
+14
+4
Price and product mix
-12
-4
+3
-6
Exchange rates
0
+2
+1
+1
+1
-3
+18
-1
34
Higher volumes in the Americas and ASPAC were driven by increased demand for our Personal Care and Home Care products. Volumes were lower in EMEA primarily due to lower demand for Home Care products. The Americas and EMEA suffered an adverse price and product mix due to increased sales of lower priced products due largely to lower raw material costs. ASPAC benefitted from a favorable price and product mix due to increased sales of higher priced products. EMEA and ASPAC benefitted from favorable exchange rate movements year over year, due to a strengthening of the British pound sterling and the European Union euro against the U.S. dollar.
Gross margin:
the year over year increase of 1.1 percentage points was due to a richer sales mix, the continued benefit of margin improvement projects and the timing of pricing movements for certain raw materials.
Operating expenses:
the year over year decrease of $2.4 million was driven by lower personnel related performance-based remuneration due to a decrease in the share-based compensation accruals linked to the Innospec share price, together with cost savings as a result of the COVID-19
pandemic, including lower travel and entertainment costs.
Oilfield Services
Net sales:
the year over year decrease of $224.9 million, or 47 percent, was primarily due to a collapse of customer activity for the U.S. onshore market, as a result of the COVID-19
pandemic reducing world-wide demand together with the depressed price of crude oil. The previously expected recovery in the U.S. completions market has been delayed, however the Company has seen an improvement in the demand for crude oil in the second half of 2020 leading to higher sales for our production and drag reducing agent products.
Gross margin:
the year over year decrease of 1.6 percentage points was primarily due to significant inventory adjustments in the second quarter of 2020 as a result of the collapse in demand, being partly offset by margin improvements in the second half of the year due to a favorable sales mix and management cost control initiatives.
Operating expenses:
the year over year decrease of $29.9 million was driven by the right-sizing
of the operations to adjust for the reduction in demand caused by the COVID-19
pandemic, together with lower accruals for long-term performance-based incentive plans due to a decrease in share-based compensation accruals linked to the Innospec share price.
Octane Additives
The Octane Additives business ceased trading and is no longer a reporting segment from July 1, 2020 as the production of TEL for use in motor gasoline has finished. Legacy costs related to these operations have now been recorded as operating expenses within corporate costs.
35
Prior to July 1, 2020 net sales were nil in 2020 compared to $21.0 million in the prior year; the gross loss was $2.2 million in 2020 compared to a $1.7 million gross profit in the prior year; operating expenses were $0.6 million in 2020 compared to $2.4 million in the prior year.
Other Income Statement Captions
Corporate costs:
the year over year decrease of $2.2 million was driven by lower accruals for long-term performance-based incentive plans due to the impact of the COVID-19
pandemic on the group’s profit performance together with a decrease in the share-based compensation accruals linked to the Innospec share price. There has also been a reduction in travel and entertainment expenses resulting from the COVID-19
pandemic restrictions on local and international travel. The decrease in costs was partly offset by $4.2 million of acquisition related costs in 2020; the inclusion of legacy costs related to the now closed Octane Additives segment of $2.5 million; and higher spending on information technology following the network security incident in the second quarter of 2019.
Restructuring charge:
was $21.3 million related to the cessation of production and sales of TEL for use in motor gasoline. See Note 5 of the Notes to the Condensed Consolidated Financial Statements for further information.
Impairment of intangible assets:
was $19.8 million related to acquired intangible assets in our Oilfield Services segment. See Note 9 of the Notes to the Condensed Consolidated Financial Statements for further information.
Other net income/(expense):
for 2020 and 2019, includes the following:
2020
2019
Change
United Kingdom pension credit
$
6.2
$
7.7
$
(1.5
)
German pension charge
(0.9
)
(0.5
)
(0.4
)
Foreign exchange gains/(losses) on translation
4.0
(1.3
)
5.3
Foreign currency forward contracts losses
(1.5
)
(0.6
)
(0.9
)
$
7.8
$
5.3
$
2.5
Interest expense, net:
was $1.8 million for 2020 compared to $4.8 million in the prior year, driven by lower average net debt as the business generated cash inflows.
Income taxes:
The effective tax rate was 27.7% and 25.4% in 2020 and 2019, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 23.5% in 2020 compared with 22.6% in 2019. 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 performance of the Company’s operations and for planning and forecasting in subsequent periods.
36
(in millions, except ratios)
2020
2019
Income before income taxes
$
39.7
$
150.4
Adjustment for stock compensation
5.8
6.6
Indemnification asset regarding tax audit
0.2
(1.6
)
Restructuring charge
21.3
0.0
Impairment of acquired intangible assets
19.8
0.0
Legacy cost of closed operations
2.5
0.0
Acquisition costs
4.2
0.0
Adjusted income before income taxes
$
93.5
$
155.4
Income taxes
$
11.0
$
38.2
Adjustment of income tax provisions
0.7
(2.5
)
Tax on stock compensation
1.7
0.9
Tax on restructuring charge
4.3
0.0
Tax on impairment of acquired intangible asset
4.6
0.0
Tax on site closure provision
0.0
(0.7
)
Tax loss on distribution
0.4
1.2
Change in UK statutory tax rate
(2.7
)
0.0
Tax on legacy cost of closed operations
0.5
0.0
Tax on acquisition costs
0.9
0.0
Other discrete items
0.6
(2.0
)
Adjusted income taxes
$
22.0
$
35.1
GAAP effective tax rate
27.7
%
25.4
%
Adjusted effective tax rate
23.5
%
22.6
%
The most significant factors impacting on our effective tax rate in 2020 are explained in Note 11 of the Notes to the Consolidated Financial Statements.
37
Results of Operations – Fiscal 2019 compared to Fiscal 2018:
(in millions, except ratios)
2019
2018
Change
Net sales:
Fuel Specialties
$
583.7
$
574.5
$
9.2
+2
%
Performance Chemicals
428.7
468.1
(39.4
)
-8
%
Oilfield Services
479.9
400.6
79.3
+20
%
Octane Additives
21.0
33.7
(12.7
)
-38
%
$
1,513.3
$
1,476.9
$
36.4
+2
%
Gross profit:
Fuel Specialties
$
204.5
$
195.0
$
9.5
+5
%
Performance Chemicals
100.1
97.5
2.6
+3
%
Oilfield Services
159.9
130.4
29.5
+23
%
Octane Additives
1.7
12.1
(10.4
)
-86
%
$
466.2
$
435.0
$
31.2
+7
%
Gross margin (%):
Fuel Specialties
35.0
33.9
+1.1
Performance Chemicals
23.3
20.8
+2.5
Oilfield Services
33.3
32.6
+0.7
Octane Additives
8.1
35.9
-27.8
Aggregate
30.8
29.5
+1.3
Operating expenses:
Fuel Specialties
$
(87.9
)
$
(78.7
)
$
(9.2
)
+12
%
Performance Chemicals
(51.4
)
(52.8
)
1.4
-3
%
Oilfield Services
(120.2
)
(108.3
)
(11.9
)
+11
%
Octane Additives
(2.4
)
(2.2
)
(0.2
)
+9
%
Corporate costs
(54.4
)
(52.4
)
(2.0
)
+4
%
Restructuring charge
0.0
(7.1
)
7.1
-100
%
$
(316.3
)
$
(301.5
)
$
(14.8
)
+5
%
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:
Change (%)
Americas
EMEA
ASPAC
AvTel
Total
Volume
-8
+4
+3
+52
+3
Price and product mix
+6
+4
+8
-37
+3
Exchange rates
0
-8
-1
0
-4
-2
0
+10
+15
+2
38
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:
Change (%)
Americas
EMEA
ASPAC
Total
Volume
-3
-4
+16
-3
Price and product mix
+4
-4
-9
-2
Exchange rates
0
-5
-3
-3
+1
-13
+4
-8
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.
39
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:
2019
2018
Change
United Kingdom pension credit
$
7.7
$
6.3
$
1.4
German pension charge
(0.5
)
(0.6
)
0.1
Foreign exchange losses on translation
(1.3
)
(5.9
)
4.6
Foreign currency forward contracts (losses)/gains
(0.6
)
5.2
(5.8
)
$
5.3
$
5.0
$
0.3
40
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 performance of the Company’s operations and for planning and forecasting in subsequent periods.
(in millions, except ratios)
2019
2018
Income before income taxes
$
150.4
$
131.6
Adjustment for stock compensation
6.6
4.8
Indemnification asset regarding tax audit
(1.6
)
(1.2
)
Site closure provision
0.0
6.8
Adjusted income before income taxes
$
155.4
$
142.0
Income taxes
$
38.2
$
46.6
Adjustment of income tax provisions
(2.5
)
(1.8
)
Tax on stock compensation
0.9
0.2
Tax Cuts & Jobs Act 2017 impact
0.0
(12.3
)
Tax on site closure provision
(0.7
)
1.9
Tax loss on distribution
1.2
0.0
Other discrete items
(2.0
)
(0.9
)
Adjusted income taxes
$
35.1
$
33.7
GAAP effective tax rate
25.4
%
35.4
%
Adjusted effective tax rate
22.6
%
23.7
%
The most significant factor impacting our adjusted effective tax rate in 2019 relates to the adjustment of income tax provisions. During 2019, the Company recorded additional tax and interest arising as a consequence of the tax audit into Innospec Performance Chemicals Italia Srl. This item had a negative impact on the effective tax rate, which has been subsequently excluded in determining the adjusted effective tax rate. We note that any finally determined tax liabilities would be reimbursed by the previous owner under the terms of the sale and purchase agreement.
The most significant factor impacting our adjusted effective tax rate in 2018 is the recognized implications of the Tax Act.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation, being the Tax Act. On the same date, 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
41
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 was completed in 2018.
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 in 2018, 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.
LIQUIDITY AND FINANCIAL CONDITION
Working Capital
In 2020 our working capital decreased by $13.0 million, while our adjusted working capital decreased by $47.5 million. The difference is primarily due to the exclusion of the increase in our cash and cash equivalents, together with the exclusion of the decrease for the current portion of our income taxes liability.
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 millions)
2020
2019
Total current assets
$
566.2
$
630.3
Total current liabilities
(252.4
)
(303.5
)
Working capital
313.8
326.8
Less cash and cash equivalents
(105.3
)
(75.7
)
Less prepaid income taxes
(4.2
)
(2.5
)
Less other current assets
(0.4
)
(0.8
)
Add back current portion of accrued income taxes
5.5
10.3
Add back current portion of finance leases
0.5
1.0
Add back current portion of plant closure provisions
6.6
5.6
Add back current portion of operating lease liabilities
11.3
10.6
Adjusted working capital
$
227.8
$
275.3
We had a $70.6 million decrease in trade and other accounts receivable primarily driven by the decline in sales in our Fuel Specialties and Oilfield Services segments as a result of the
42
COVID-19
pandemic. Days’ sales outstanding in our Fuel Specialties segment remained unchanged at 52 days; decreased in our Performance Chemicals segment from 64 days to 60 days; and decreased from 66 days to 63 days in our Oilfield Services segment.
We had a $24.6 million decrease in inventories, net of a $4.9 million increase in allowances, as we managed inventory levels in anticipation of increased demand that we expect in 2021. Days’ sales in inventory in our Fuel Specialties segment increased from 97 days to 117 days; decreased in our Performance Chemicals segment from 66 days to 58 days; and increased from 71 days to 95 days in our Oilfield Services segment.
Prepaid expenses increased $0.2 million, from $14.7 million to $14.9 million.
We had a $47.5 million decrease in accounts payable and accrued liabilities primarily due to lower production activity to align with reduced customer demand, together with lower accruals for share-based payments linked to the decrease in the Innospec share price during the year. Creditor days (including goods received not invoiced) in our Fuel Specialties segment decreased from 52 days to 34 days; decreased in our Performance Chemicals segment from 54 days to 48 days; and increased from 43 days to 49 days in our Oilfield Services segment.
Operating Cash Flows
We generated cash from operating activities of $145.9 million in 2020 compared to cash inflows of $161.6 million in 2019. The reduction in cash generated from operating activities was primarily related to the adverse impact of COVID-19
and the fall in oil prices on customer activity and the timing of payments for income taxes.
Cash
At December 31, 2020 and 2019, we had cash and cash equivalents of $105.3 million and $75.7 million, respectively, of which $52.5 million and $57.9 million, respectively, were held by non-U.S.
subsidiaries principally in the United Kingdom.
The increase in cash and cash equivalents in 2020 of $29.6 million was primarily driven by the cash inflows from operating activities including our reductions in working capital, being partly offset by the repayment of $60.0 million of our revolving credit facility together with the normal investments in capital projects and the payment of our semi-annual dividends.
Debt
As at December 31, 2020, the Company had repaid all of its borrowings under the revolving credit facility and as a result, the related deferred finance costs of $1.3 million are now included within other current and non-current
assets at the balance sheet date.
On September 16, 2020, Innospec and certain of its subsidiaries agreed to extend the term of its revolving credit facility, as described below, until September 25, 2024. The costs of $0.3 million for extending the term have been capitalized on the balance sheet, which are being amortized over the expected life of the facility.
43
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.
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.
The 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 revolving 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, 2020, we had no debt outstanding under the revolving credit facility and $0.6 million of obligations under finance leases relating to certain fixed assets within our Fuel Specialties and Oilfield Services segments.
At December 31, 2020, our maturity profile of long-term debt and finance leases is set out below:
(in millions)
2021
$
0.5
2022
0.1
2023
0.0
2024
0.0
Total debt
0.6
Current portion of long-term debt and finance leases
(0.1
)
Long-term debt and finance leases, net of current portion
$
0.5
44
Outlook
During the early part of 2020, we focused on growing our business and on developing a strong pipeline of what we believe to be promising organic growth projects to support future growth.
For the rest of the year, while we have continued this strategy, we have also had to deal with the impacts of the COVID-19
pandemic and the collapse in crude oil prices. These events created unprecedented demand destruction.
However, our financial performance in this difficult environment, combined with our strong balance sheet and financial prudence have been the solid foundation on which we have been able to weather this storm. Indeed, we ended the year with a very strong net cash position and we had no requirement to call on additional financial support from our banks during the pandemic. We believe this financial strength means that we are well-placed to resource growth projects – both organic and acquisitive.
We believe that our long-term strategy remains valid and this has been supported by the recovery in markets towards the end of 2020.
While we are optimistic for prospects in 2021 and beyond, we are also cautious given the current circumstances. The global pandemic is not yet under control and has the potential to adversely impact demand in the near term.
We will continue our strategy of investing in R&D to continuously improve our products and technology. When these innovations are combined with high quality customer service, we are confident that we have a solid foundation of future organic growth.
We also remain active in corporate development, and we enter 2021 with balance sheet strength which gives us the ability to participate in appropriate acquisition opportunities as they arise.
45
Contractual Commitments
The following represents contractual commitments at December 31, 2020 and the effect of those obligations on future cash flows:
(in millions)
Total
2021
2022-23
2024-25
Thereafter
Operating activities
Remediation payments
58.5
6.6
9.4
7.1
35.4
Operating lease commitments
40.2
11.3
17.3
8.9
2.7
Raw material purchase obligations
19.7
3.8
7.8
8.1
0.0
Interest payments on debt
3.4
0.9
1.8
0.7
0.0
Investing activities
Capital commitments
14.7
14.7
0.0
0.0
0.0
Financing activities
Long-term debt obligations
0.0
0.0
0.0
0.0
0.0
Finance leases
0.6
0.5
0.1
0.0
0.0
Total
$
137.1
$
37.8
$
36.4
$
24.8
$
38.1
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 11 of the Notes to the Consolidated Financial Statements.
46
Investing activities
Capital commitments relate to certain capital projects that the Company has committed to undertake.
Financing activities
On September 16, 2020, Innospec and certain of its subsidiaries agreed to extend the term of its revolving credit facility, as described below, until September 25, 2024.
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.
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.
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 $58.5 million at December 31, 2020. Remediation expenditure utilizing these provisions was $4.1 million, $4.4 million and $3.1 million in the years 2020, 2019 and 2018, respectively.
47