Item 8. Financial Statements and Supplementary Data
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 sheets of Innospec Inc. and its subsidiaries
(the “Company”) as of December 31, 2020 and 2019,
and the related consolidated statements of income, comprehensive income, equity
and cash flows for each of the two years in the period ended December 31, 2020, 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, 2020, 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, 2020 and 2019 ,
and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2020 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, 2020, 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 audits. 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 audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the
51
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 audits 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 audits 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 audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide 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
52
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 13 to the consolidated financial statements, at December 31, 2020 there is a provision in place for $58.5 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 17, 2021.
We have served as the Company’s auditor since 2019 .
53
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Innospec Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statements of income, comprehensive income, cash flows and equity of Innospec, Inc. and subsidiaries (the Company) for the year ended December 31, 2018, 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 operations of the Company and its cash flows for the year ended December 31, 2018, 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
We served as the Company’s auditor from 2011 to 2019.
Manchester, United Kingdom
February 20, 2019
54
CONSOLIDATED STATEMENTS OF INCOME
( in millions, except share and per share data
)
Years ended December 31
2020
2019
2018
Net sales
$
1,193.1
$
1,513.3
$
1,476.9
Cost of goods sold
( 850.4
)
( 1,047.1
)
( 1,041.9
)
Gross profit
342.7
466.2
435.0
Operating expenses:
Selling, general and administrative
( 237.0
)
( 280.9
)
( 261.0
)
Research and development
( 30.9
)
( 35.4
)
( 33.4
)
Restructuring charge
( 21.3
)
0.0
( 7.1
)
Impairment of intangible assets
( 19.8
)
0.0
0.0
Total operating expenses
( 309.0
)
( 316.3
)
( 301.5
)
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 tax expense
39.7
150.4
131.6
Income tax expense
( 11.0
)
( 38.2
)
( 46.6
)
Net income
$
28.7
$
112.2
$
85.0
Earnings per share:
Basic
$
1.17
$
4.58
$
3.48
Diluted
$
1.16
$
4.54
$
3.45
Weighted average shares outstanding (in thousands):
Basic
24,563
24,482
24,401
Diluted
24,779
24,728
24,603
The accompanying notes are an integral part of these statements.
55
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
( in millions
)
Total comprehensive income for the years ended December 31
2020
2019
2018
Net income
$
28.7
$
112.2
$
85.0
Changes in cumulative translation adjustment, net of tax of $ 3.9
million, $( 0.3
) million and $ 2.7 million, respectively
23.7
( 6.0
)
( 22.6
)
Changes in derivative instruments, net of tax of $ 0.0 million, $( 0.4 ) million and $( 0.1 ) million, respectively
0.0
( 1.5
)
0.3
Amortization of prior service credit, net of tax of $ 0.1 million, $ 0.2 million and $ 0.2 million, respectively
( 0.4
)
( 0.7
)
( 0.9
)
Amortization of actuarial net losses, net of tax of $( 0.2 ) million, $ 0.0 million and $( 0.3 ) million, respectively
1.5
0.0
1.7
Actuarial net (losses)/gains arising during the year, net of tax of $ 1.9 million, $( 2.2 ) million and $ 3.3 million, respectively
( 7.7
)
9.5
( 15.7
)
Total comprehensive income
$
45.8
$
113.5
$
47.8
The accompanying notes are an integral part of these statements.
56
CONSOLIDATED BALANCE SHEETS
( in millions, except share and per share data
)
At December 31
2020
2019
Assets
Current assets:
Cash and cash equivalents
$
105.3
$
75.7
Trade and other accounts receivable (less allowances of $ 4.5
million and $ 3.8
million, respectively)
221.4
292.0
Inventories (less allowances of $ 19.4
million and $ 14.5
million, respectively):
Finished goods
156.3
173.9
Raw materials
63.7
70.7
Total inventories
220.0
244.6
Prepaid expenses
14.9
14.7
Prepaid income taxes
4.2
2.5
Other current assets
0.4
0.8
Total current assets
566.2
630.3
Net property, plant and equipment
210.8
198.7
Operating leases right-of-use
assets
40.1
32.4
Goodwill
371.2
363.0
Other intangible assets
75.3
113.5
Deferred tax assets
7.6
9.1
Pension asset
118.0
115.9
Other non-current
assets
8.2
5.9
Total assets
$
1,397.4
$
1,468.8
Liabilities and Equity
Current liabilities:
Accounts payable
$
98.7
$
122.0
Accrued liabilities
129.8
154.0
Current portion of finance leases
0.5
1.0
Current portion of plant closure provisions
6.6
5.6
Current portion of accrued income taxes
5.5
10.3
Current portion of operating lease liabilities
11.3
10.6
Total current liabilities
252.4
303.5
Long-term debt, net of current portion
0.0
58.6
Finance leases, net of current portion
0.1
0.5
Operating lease liabilities, net of current portion
28.9
21.9
Plant closure provisions, net of current portion
51.9
43.7
Accrued income taxes, net of current portion
32.4
36.2
Unrecognized tax benefits, net of current portion
16.0
16.4
Deferred tax liabilities
46.9
49.6
Pension liabilities and post-employment benefits
20.5
17.8
Other non-current
liabilities
3.4
1.7
Equity:
Common stock, $ 0.01 par value, authorized 40,000,000 shares, issued 29,554,500
shares
0.3
0.3
Additional paid-in
capital
336.1
330.4
Treasury stock ( 4,958,599 and 5,047,278 shares at cost, respectively)
( 93.3
)
( 93.3
)
Retained earnings
758.6
755.5
Accumulated other comprehensive loss
( 57.3
)
( 74.4
)
Total Innospec stockholders’ equity
944.4
918.5
Non-controlling
interest
0.5
0.4
Total equity
944.9
918.9
Total liabilities and equity
$
1,397.4
$
1,468.8
The accompanying notes are an integral part of these statements.
57
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Years ended December 31
2020
2019
2018
Cash Flows from Operating Activities
Net income
$
28.7
$
112.2
$
85.0
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization
46.0
47.6
49.6
Impairment of intangible assets
19.8
0.0
0.0
Impairment of tangible assets
2.0
0.0
0.0
Deferred tax (benefit)/expense
( 2.5
)
( 0.8
)
5.5
Cash contributions to defined benefit pension plans
0.0
( 0.4
)
( 1.0
)
Non-cash
income of defined benefit pension plans
( 4.0
)
( 6.1
)
( 4.3
)
Stock option compensation
5.8
6.6
4.9
Changes in assets and liabilities, net of effects of acquired and divested companies:
Trade and other accounts receivable
74.4
( 18.2
)
( 40.1
)
Inventories
25.5
2.4
( 42.2
)
Prepaid expenses
( 1.0
)
( 3.1
)
0.5
Accounts payable and accrued liabilities
( 45.9
)
23.2
38.4
Accrued income taxes
( 10.3
)
( 2.4
)
( 6.1
)
Plant closure provisions
8.5
0.0
3.6
Unrecognized tax benefits
( 0.4
)
2.5
11.5
Other assets and liabilities
( 0.7
)
( 1.9
)
( 0.4
)
Net cash provided by operating activities
145.9
161.6
104.9
Cash Flows from Investing Activities
Capital expenditures
( 29.7
)
( 29.9
)
( 28.9
)
Business combinations, net of cash acquired
0.0
0.0
( 5.4
)
Internally developed software
0.0
( 1.1
)
( 1.2
)
Net cash used in investing activities
( 29.7
)
( 31.0
)
( 35.5
)
Cash Flows from Financing Activities
Non-controlling
interest
0.1
0.0
0.0
Proceeds from revolving credit facility
15.0
105.5
10.0
Repayments of revolving credit facility
( 75.0
)
( 171.5
)
( 5.0
)
Repayment of term loans
0.0
( 82.5
)
( 16.5
)
Repayment of finance leases
( 1.1
)
( 1.7
)
( 2.7
)
Refinancing costs
( 0.3
)
( 1.5
)
0.0
Dividend paid
( 25.6
)
( 25.0
)
( 21.7
)
Issue of treasury stock
2.2
1.2
1.1
Repurchase of common stock
( 2.1
)
( 2.4
)
( 1.4
)
Net cash used in financing activities
( 86.8
)
( 177.9
)
( 36.2
)
Effect of foreign currency exchange rate changes on cash
0.2
( 0.1
)
( 0.3
)
Net change in cash and cash equivalents
29.6
( 47.4
)
32.9
Cash and cash equivalents at beginning of year
75.7
123.1
90.2
Cash and cash equivalents at end of year
$
105.3
$
75.7
$
123.1
The accompanying notes are an integral part of these statements.
58
CONSOLIDATED STATEMENTS OF EQUITY
( in millions
)
Common
Stock
Additional
Paid-In
Capital
Treasury
Stock
Retained
Earnings
Accumulated
Other
Comprehensive
Loss
Non-
controlling
Interest
Total
Equity
Balance at December 31, 2017
$
0.3
$
320.4
$
( 93.3
)
$
605.0
$
( 38.5
)
$
0.4
$
794.3
Net income
85.0
85.0
Dividend paid ($ 0.89
per share)
( 21.7
)
( 21.7
)
Changes in cumulative translation adjustment, net of tax
( 22.6
)
( 22.6
)
Share of net income
0.1
0.1
Change in derivative instruments, net of tax
0.3
0.3
Treasury stock re-issued
( 0.4
)
1.9
1.5
Treasury stock repurchased
( 1.4
)
( 1.4
)
Stock option compensation
4.9
4.9
Amortization of prior service credit, net of tax
( 0.9
)
( 0.9
)
Amortization of actuarial net losses, net of tax
1.7
1.7
Actuarial net losses arising during the year, net of tax
( 15.7
)
( 15.7
)
Balance at December 31, 2018
$
0.3
$
324.9
$
( 92.8
)
$
668.3
$
( 75.7
)
$
0.5
$
825.5
Net income
112.2
112.2
Dividend paid ($ 1.02
per share)
( 25.0
)
( 25.0
)
Changes in cumulative translation adjustment, net of tax
( 6.0
)
( 6.0
)
Share of net income
( 0.1
)
( 0.1
)
Changes in derivative instruments, net of tax
( 1.5
)
( 1.5
)
Treasury stock re-issued
( 1.1
)
1.9
0.8
Treasury stock repurchased
( 2.4
)
( 2.4
)
Stock option compensation
6.6
6.6
Amortization of prior service credit, net of tax
( 0.7
)
( 0.7
)
Actuarial net gains arising during the year, net of tax
9.5
9.5
Balance at December 31, 2019
$
0.3
$
330.4
$
( 93.3
)
$
755.5
$
( 74.4
)
$
0.4
$
918.9
Net income
28.7
28.7
Dividend paid ($ 1.04
per share)
( 25.6
)
( 25.6
)
Changes in cumulative translation adjustment, net of tax
23.7
23.7
Share of net income
0.1
0.1
Treasury stock re-issued
( 0.1
)
2.1
2.0
Treasury stock repurchased
( 2.1
)
( 2.1
)
Stock option compensation
5.8
5.8
Amortization of prior service credit, net of tax
( 0.4
)
( 0.4
)
Amortization of actuarial net losses, net of tax
1.5
1.5
Actuarial net gains arising during the year, net of tax
( 7.7
)
( 7.7
)
Balance at December 31, 2020
$
0.3
$
336.1
$
( 93.3
)
$
758.6
$
( 57.3
)
$
0.5
$
944.9
The accompanying notes are an integral part of these statements.
59
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Nature of Operation s
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 refiners, 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 (ceased trading June 30, 2020).
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
60
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.
61
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Research and development expenses:
Research, development and testing costs are expensed to the income statement as incurred.
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
62
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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.
Credit losses:
With an effective date of January 1, 2020, we have applied Accounting Standards Update (ASU) No. 2016-13,
Financial Instruments – Credit Losses (ASC Topic 326). This replaces the incurred loss impairment methodology under previous 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.
The standard was adopted using prospective application and principally impacts the allowance for trade and other accounts receivables. Upon adoption, there was no adjustment made to opening retained earnings as at January 1, 2020. As a result of implementing the standard, the Company did not recognize any material change to the allowance within trade and other accounts receivable as at January 1, 2020. Trade and other accounts receivable are shown net of a $ 4.5 million allowance at December 31
, 2020. The allowance remains immaterial to the financial statements.
The Company is exposed to credit losses primarily through sales of products. The Company’s expected loss allowance methodology for trade and other accounts receivable is developed using historical collection experience, current and future economic and market conditions and a review of the current status of customers’ receivables. Due to the short-term nature of such receivables, the estimate of accounts receivable amounts that may not be collected is based on aging of the accounts receivable balances and the financial condition of customers. Additionally, a further allowance is included to account for the Company’s historic track record of credit losses, for balances which are not aged sufficiently to be considered under the aging based approach.
The Company considered the current and expected future economic and market conditions surrounding the COVID-19
pandemic and determined that the estimate of credit losses was not significantly impacted.
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
6 3
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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:
Buildings
7
to 25
years
Equipment
3 to 10
years
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.
O ther 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
64
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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:
Technology
10
to 17
years
Customer lists
10
to 15
years
Brand names
5
to 10
years
Product rights
9
to 10
years
Internally developed software
3 to 5
years
Marketing related
11 years
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.
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, 2020. 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, 2020.
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
6 5
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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 are 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.
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.
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.
6 6
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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 financial statement carrying amounts and the relevant tax bases of the assets and liabilities. The Company then 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.
6 7
NOTES
TO THE CONSOLIDATED
FINANCIAL STATEMENTS—( Continued
)
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 ceased trading and is no longer a reporting segment from July 1, 2020, as reported
in our Quarterly Report on Form 10-Q
for the quarter ended June 30, 2020.
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 chemical solutions for fracturing, stimulation and stimulation operations, products for oil and gas production which aid flow assurance and maintain asset integrity and products to prevent loss of mud in drilling operations.
The Octane Additives business has 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 are now being recorded as operating expenses within corporate costs.
There are no significant customers with sales greater than 10% of our net group sales in the last three financial years.
6 8
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:
(in millions)
2020
2019
2018
Net Sales:
Refinery and Performance
$
372.9
$
427.9
$
432.1
Other
139.8
155.8
142.4
Fuel Specialties
512.7
583.7
574.5
Personal Care
231.4
228.0
241.4
Home Care
87.0
93.4
109.1
Other
107.0
107.3
117.6
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
(in millions)
2020
2019
2018
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/(expense):
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
Identifiable assets at year end:
Fuel Specialties
$
509.7
$
499.7
$
470.5
Performance Chemicals
391.5
383.3
463.9
Oilfield Services
210.8
316.8
296.1
Octane Additives
0.0
24.2
39.6
Corporate
285.4
244.8
203.3
$
1,397.4
$
1,468.8
$
1,473.4
69
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Identifiable assets relating to our tetra ethyl lead (“TEL”) operations are included within our Fuel Specialties segment in 2020 and in our Octane Additives segment in 2019 and 2018, as shown in the table above. Octane Additives ceased trading on June 30, 2020 and is no longer a reporting segment after that date. As a result, it is now appropriate to report the identifiable assets relating to the remaining TEL production within Fuel Specialties from July 1, 2020. Our TEL operations historically produced TEL for automotive gasoline, which is reported in our Octane Additives segment for the years presented above, and for our AvTel product line, which is reported in our Fuel Specialties segment.
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, product technology, safety, health, environment, accounting and human resources departments.
The following tables analyze sales and other financial information by location:
(in millions)
2020
2019
2018
Net sales by source:
United States & North America
$
642.4
$
897.2
$
803.1
United Kingdom
689.1
810.9
797.5
Rest of Europe
83.4
115.7
143.7
Rest of World
45.6
47.8
29.5
Sales between areas
( 267.4
)
( 358.3
)
( 296.9
)
$
1,193.1
$
1,513.3
$
1,476.9
Income before income taxes:
United States & North America
$
0.0
$
53.9
$
37.1
United Kingdom
16.9
67.0
59.5
Rest of Europe
19.7
27.2
32.8
Rest of World
3.1
2.3
2.2
$
39.7
$
150.4
$
131.6
Long-lived assets at year end:
United States & North America
$
141.0
$
156.0
$
148.6
United Kingdom
61.3
70.4
71.6
Rest of Europe
123.2
116.6
112.2
Rest of World
0.2
0.3
0.3
$
325.7
$
343.3
$
332.7
70
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions)
2020
2019
2018
Identifiable assets at year end:
United States & North America
$
368.8
$
419.5
$
402.5
United Kingdom
455.8
487.2
504.7
Rest of Europe
171.0
163.2
173.1
Rest of World
30.6
35.9
28.2
Goodwill
371.2
363.0
364.9
$
1,397.4
$
1,468.8
$
1,473.4
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:
2020
2019
2018
Numerator (in millions):
Net income available to common stockholders
$
28.7
$
112.2
$
85.0
Denominator (in thousands):
Weighted average common shares outstanding
24,563
24,482
24,401
Dilutive effect of stock options and awards
216
246
202
Denominator for diluted earnings per share
24,779
24,728
24,603
Net income per share, basic:
$
1.17
$
4.58
$
3.48
Net income per share, diluted:
$
1.16
$
4.54
$
3.45
In 2020, 2019 and 2018 the average number
of anti-dilutive options excluded from the calculation of diluted earnings per share were
17,980 , 6,270 and
0 respectively.
Note 5. Restructuring
During 2020, the Company recorded a charge
of $ 21.3 million for the restructuring of its Octane Additives segment in line with the end of the manufacturing and sale of TEL for use in
71
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
motor gasoline. As a result, the Octane Additives segment ceased trading and is no longer a reporting segment from July 1, 2020. Production of TEL will continue for sales to the aviation market (“AvTel”), as reported within our Fuel Specialties segment.
The restructuring charge
comprise s
the future committed costs of environmental monitoring of $ 2.0 million, remediation of facilities of $ 7.5 million, contract termination costs o f
$ 7.2 million, impairment of tangible assets of $ 2.0 million and costs of redundancy due to the down-sizing
of the TEL operations of $ 2.6 million. During the year
ended December 31
, 2020 the utilization and the unwinding of the discounting was not material.
Note 6. Property, Plant and Equipment
Property, plant and equipment consists of the following:
(in millions)
2020
2019
Land
$
21.6
$
19.8
Buildings
65.5
60.0
Equipment
349.9
330.7
Work in progress
27.5
19.0
464.5
429.5
Less accumulated depreciation and impairment
( 253.7
)
( 230.8
)
$
210.8
$
198.7
Of the total net book value of equipment at December 31, 2020 $ 1.0 million (2019 – $ 1.8 million) are in respect of assets held under finance leases.
Depreciation charges were $ 24.7 million, $ 23.6 million and $ 22.6 million in 2020, 2019 and 2018, respectively.
An impairment charge of $ 2.0 million was incurred in 2020
as a result of the Octane Additives segment ceasing to trade on June 30, 2020.
Note 7. 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 10 years , some of which include options to terminate the leases within 1 year .
72
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The components of lease expense were as follows:
(in millions)
Twelve Months
Ended December 31
Twelve Months
Ended December 31
2020
2019
Finance lease cost:
Amortization of right-of-use
assets
$
1.0
$
1.7
Interest on lease liabilities
0.0
0.0
Total finance lease cost
1.0
1.7
Operating lease cost
12.8
12.1
Short-term lease cost
3.2
2.5
Variable lease cost
0.3
0.3
Total lease cost
$
17.3
$
16.6
Supplemental cash flow information related to leases is as follows:
(in millions)
Twelve Months
Ended December 31
Twelve Months
Ended December 31
2020
2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
$
15.9
$
14.3
Operating cash flows from finance leases
1.2
2.1
Finance cash flows from finance leases
0.0
0.0
Right-of-use
assets obtained in exchange for new lease obligations:
Operating leases
$
5.7
$
4.3
Finance leases
0.0
0.0
73
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Supplemental balance sheet information related to leases is as follows:
(in millions except lease term and discount rate)
December 31
2020
December 31
2019
Operating leases:
Operating lease right-of-use
assets
$
40.1
$
32.4
Current portion of operating lease liabilities
$
11.3
$
10.6
Operating lease liabilities, net of current portion
28.9
21.9
Total operating lease liabilities
$
40.2
$
32.5
Finance leases:
Property, plant and equipment at cost
$
9.0
$
9.9
Accumulated depreciation
( 8.0
)
( 8.1
)
Net property, plant and equipment
$
1.0
$
1.8
Current portion of finance leases
$
0.5
$
1.0
Finance leases, net of current portion
0.1
0.5
Total finance lease liabilities
$
0.6
$
1.5
Weighted average remaining lease term:
Operating leases
4.1 years
3.3 years
Finance leases
1.1 years
1.7 years
Weighted average discount rate:
Operating leases
3.0
%
3.1
%
Finance leases
2.6
%
2.4
%
Maturities of lease liabilities were as follows as at December 31, 2020:
(in millions)
Operating
Leases
Finance
Leases
Within one year
$
11.4
$
0.5
Year two
9.4
0.1
Year three
8.2
0.0
Year four
5.5
0.0
Year five
3.8
0.0
Thereafter
4.6
0.0
Total lease payments
42.9
0.6
Less imputed interest
( 2.7
)
0.0
Total
$
40.2
$
0.6
74
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
As of December 31, 2020, additional operating and finance leases that have not yet commenced are $
0.0
million.
Future lease payment for all non-cancellable
operating and finance leases as of December 31, 2019 were as follows:
(in millions)
Operating
Leases
Finance
Leases
Within one year
$
10.8
$
1.1
Year two
9.1
0.4
Year three
5.8
0.1
Year four
4.4
0.0
Year five
2.1
0.0
Thereafter
2.5
0.0
Total lease payments
34.7
1.6
Less imputed interest
( 2.2
)
( 0.1
)
Total
$
32.5
$
1.5
As of December 31, 2019, additional operating and finance leases that have not yet commenced are $ 0.0
million.
Note 8. Goodwill
The following table analyzes goodwill movement for 2020 and 2019.
(in millions)
Fuel
Specialties
Performance
Chemicals
Oilfield
Services
Octane
Additives
Total
At December 31, 2018
Gross cost (1)
$
207.9
$
112.2
$
44.8
$
236.5
$
601.4
Accumulated impairment losses
0.0
0.0
0.0
( 236.5
)
( 236.5
)
Net book amount
$
207.9
$
112.2
$
44.8
$
0.0
$
364.9
Exchange effect
( 0.2
)
( 1.7
)
0.0
0.0
( 1.9
)
At December 31, 2019
Gross cost
(1)
$
207.7
$
110.5
$
44.8
$
236.5
$
599.5
Accumulated impairment losses
0.0
0.0
0.0
( 236.5
)
( 236.5
)
Net book amount
$
207.7
$
110.5
$
44.8
$
0.0
$
363.0
Exchange effect
0.2
8.0
0.0
0.0
8.2
At December 31, 2020
Gross cost
(1)
$
207.9
$
118.5
$
44.8
$
0.0
$
371.2
Accumulated impairment losses
0.0
0.0
0.0
0.0
0.0
Net book amount
$
207.9
$
118.5
$
44.8
$
0.0
$
371.2
75
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS—( Continued
)
(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 and Oilfield Services. The Octane Additives segment has ceased trading and is no longer a reporting segment from July 1, 2020, as reported in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2020. As a result the gross cost and the accumulated impairment losses have been written down to nil .
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, 2020, 2019 and 2018. Our impairment assessment concluded that there had been
no
impairment of goodwill in respect of those reporting units. 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.
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.
76
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Note 9. Other Intangible Assets
Other intangible assets comprise the following:
(in millions)
2020
2019
Gross cost at January 1
$
294.8
$
294.6
Additions
0.0
1.1
Exchange effect
4.1
( 0.9
)
Gross cost at December 31
298.9
294.8
Accumulated amortization at January 1
( 181.3
)
( 158.3
)
Amortization expense
( 20.9
)
( 23.0
)
Impairment
( 19.8
)
0.0
Exchange effect
( 1.6
)
0.0
Accumulated amortization at December 31
( 223.6
)
( 181.3
)
Net book amount at December 31
$
75.3
$
113.5
Amortization expense
The amortization expense was $ 20.9 million, $ 23.0 million and $ 26.3 million in 2020, 2019 and 2018, respectively. Excluding the impact of foreign exchange translation on the balance sheet, $ 2.9 million, $ 3.4 million and $ 3.4 million of amortization, respectively, was recognized in cost of goods sold, and the remainder was recognized in selling, general and administrative expenses.
During the quarter ended June 30, 2020, the Company performed an impairment review over the assets of each operating segment. This indicated the fair values substantially exceeded the carrying values for all operating segments. Further, the Company also performed an impairment review over each of the businesses within the Oilfield Services segment, as a result of reduction in demand for drilling related products. A discounted cash flow analysis was performed to determine the fair value of the assets. This indicated that the intangible assets arising from the acquisition of Strata Control Services Inc. were impaired. The impaired assets relate to technology ($ 10.0 million) and customer relationships ($ 9.8 million). There was no impairment indicated on the other businesses within the Oilfield Services operating segment.
77
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The net book amount by category of other intangible assets is shown in the following table:
(in millions)
December 31
2020
December 31
2019
Product rights
$
6.3
$
10.1
Brand names
2.3
2.9
Technology
19.8
32.6
Customer relationships
44.2
60.8
Internally developed software
2.7
7.1
$
75.3
$
113.5
Future amortization expense is estimated to be as follows for the next five years:
(in millions)
2021
$
15.9
2022
$
14.3
2023
$
10.9
2024
$
10.2
2025
$
7.2
Note 10. 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 2020, the Company contributed $ 0.0 million (2019 – $ 0.4 million) in cash to the Plan in accordance with an agreement with the trustees.
78
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The net service cost for the twelve months ended December 31, 2020 was $ 1.2 million (twelve months ended December 31, 2019 – $ 0.9 million and twelve months ended December 31, 2018 – 1.2 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:
(in millions)
2020
2019
2018
Plan net pension (credit)/charge:
Interest cost on PBO
$
11.2
$
15.2
$
15.0
Expected return on plan assets
( 17.8
)
( 22.0
)
( 22.2
)
Amortization of prior service credit
( 0.5
)
( 0.9
)
( 1.1
)
Amortization of actuarial net losses
0.9
0.0
2.0
$
( 6.2
)
$
( 7.7
)
$
( 6.3
)
Plan assumptions at December 31, (%):
Discount rate
1.36
1.95
2.78
Inflation rate
2.35
2.25
2.25
Rate of return on plan assets – overall on bid-value
2.00
2.50
3.05
Plan asset allocation by category (%):
Debt securities and insurance contracts
86
86
83
Equity securities and real estate
10
10
12
Cash
4
4
5
100
100
100
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 model used to develop the discount rate for the year ending December 31, 2019 has been updated for the year ending December 31, 2020. Management’s experts have used the same data source as the prior year for the bond rate used to determine the discount rate, however this data source now uses inputs from a different range of categories of bonds. The impact of this change has resulted in an increase of 0.13 % in the discount rate assumption, which has resulted in a reduction to the Pension Benefit Obligation of around $ 14 million.
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 at December 31, 2020 by approximately
$ 26 million
and the net pension credit for 2021 would change by approximately
$ 0.4 million. A 0.25 % change in the level of price inflation assumption would change the PBO at December 31, 2020 by approximately
$ 19 million and the net pension credit for 2021 by approximately
$ 1.2 million.
79
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Movements in PBO and fair value of Plan assets are as follows:
(in millions)
2020
2019
Change in PBO:
Opening balance
$
701.0
$
643.2
Interest cost
11.2
15.2
Service cost
1.2
0.9
Benefits paid
( 45.5
)
( 42.1
)
Plan amendments
5.5
0.0
Actuarial losses
61.1
57.7
Exchange effect
24.2
26.1
Closing balance
$
758.7
$
701.0
Fair value of plan assets:
Opening balance
$
816.9
$
739.1
Benefits paid
( 45.5
)
( 42.1
)
Actual contributions by employer
0.0
0.4
Actual return on assets
77.6
89.1
Exchange effect
27.7
30.4
Closing balance
$
876.7
$
816.9
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.
The Plan holds approximately 11 % (December 31, 2019 – 12 %) 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
80
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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.
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:
(in millions)
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
At December 31, 2020
Debt securities
:
Debt securities issued by non-U.S.
governments and government agencies
$
99.5
$
$
$
99.5
Corporate debt securities
488.0
488.0
Equity backed securities:
Other financial derivatives
( 2.3
)
( 2.3
)
Investments measured at net asset
value (1)
51.0
Other asset backed securities:
Insurance contracts
167.4
167.4
Real estate
40.2
40.2
Total assets at fair value
139.7
485.7
167.4
843.8
Cash
32.9
32.9
Total plan assets
$
172.6
$
485.7
$
167.4
$
876.7
81
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions)
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
At December 31, 2019
Debt securities:
Debt securities issued by non-U.S.
governments and government agencies
$
98.4
$
$
$
98.4
Corporate debt securities
445.9
445.9
Equity backed securities:
Other financial derivatives
( 3.7
)
( 3.7
)
Investments measured at net asset value (1)
46.8
Other asset backed securities:
Insurance contracts
157.9
157.9
Real estate
41.7
41.7
Total assets at fair value
140.1
442.2
157.9
787.0
Cash
29.9
29.9
Total plan assets
$
170.0
$
442.2
$
157.9
$
816.9
(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.
The reconciliation of the fair value of the Plan assets measured using significant unobservable inputs was as follows:
(in millions)
Other
Assets
Balance at December 31, 2018
$
142.5
Realized/unrealized gains/(losses):
Relating to assets still held at the reporting date
16.0
Purchases, issuances and settlements
( 6.5
)
Exchange effect
5.9
Balance at December 31, 2019
$
157.9
Realized/unrealized gains/(losses):
Relating to assets still held at the reporting date
10.8
Purchases, issuances and settlements
( 6.6
)
Exchange effect
5.3
Balance at December 31, 2020
$
167.4
82
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The projected net service cost for the year ending December 31, 2021 is $ 1.6 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 millions)
Interest cost on PBO
$
7.5
Expected return on plan assets
( 15.4
)
Amortization of prior service credit
0.3
Amortization of actuarial net losses
1.6
$
( 6.0
)
In total, there will be a net pension credit of $ 4.4 million to the Innospec’s net income for the year ending December 31, 2021.
The following benefit payments are expected to be made:
(in millions)
2021
$
43.9
2022
$
36.9
2023
$
35.9
2024
$
36.1
2025
$
35.8
2026-2030
$
172.0
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, 2020 was $ 0.1 million (twelve months ended December 31, 2019 – $ 0.1 million and twelve months ended December 31, 2018 – $ 0.2 million).
The following table shows the income statement effect recognized within other income and expense:
(in millions)
2020
2019
2018
Plan net pension charge:
Interest cost on PBO
$
0.1
$
0.2
$
0.2
Amortization of actuarial net loss
0.8
0.3
0.4
$
0.9
$
0.5
$
0.6
83
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Plan assumptions at December 31, (%):
Discount rate
0.40
0.80
1.90
Inflation rate
1.50
1.75
1.75
Rate of increase in compensation levels
2.75
2.75
2.75
Movements in PBO of the German plan are as follows:
(in millions)
2020
2019
Change in PBO:
Opening balance
$
13.3
$
11.3
Service cost
0.1
0.1
Interest cost
0.1
0.2
Benefits paid
( 0.3
)
( 0.3
)
Actuarial losses
0.8
2.2
Exchange effect
1.2
( 0.2
)
Closing balance
$
15.2
$
13.3
Other plans
As at December 31, 2020, we have post-employment obligations in our European businesses with a liability of $ 5.3 million (December 31, 2019 – $ 4.5 million). For the year ended December 31, 2020 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 2020 were $ 10.3 million (2019 – $ 10.4 million).
84
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Note 11. Income Taxes
A roll-forward of unrecognized tax benefits and associated accrued interest and penalties is as follows:
(in millions)
Unrecognised
Tax Benefits
Interest
and
Penalties
Total
Opening balance at January 1, 2018
$
2.2
$
0.3
$
2.5
Additions for tax positions of prior periods
11.7
0.4
12.1
Reductions due to lapsed statute of limitations
( 0.5
)
( 0.1
)
( 0.6
)
Closing balance at 31 December, 2018
13.4
0.6
14.0
Current
0.0
0.0
0.0
Non-current
$
13.4
$
0.6
$
14.0
Opening balance at January 1, 2019
$
13.4
$
0.6
$
14.0
Additions for tax positions of prior periods
1.0
1.4
2.4
Closing balance at 31 December, 2019
14.4
2.0
16.4
Current
0.0
0.0
0.0
Non-current
$
14.4
$
2.0
$
16.4
Opening balance at January 1, 2020
$
14.4
$
2.0
$
16.4
Reductions for tax positions of prior periods
( 1.2
)
( 0.2
)
( 1.4
)
Additions for tax positions of prior periods
0.4
0.6
1.0
Closing balance at 31 December, 2020
13.6
2.4
16.0
Current
0.0
0.0
0.0
Non-current
$
13.6
$
2.4
$
16.0
All of the $ 16.0 million of unrecognised tax benefits would impact our effective tax rate if recognised.
As previously disclosed, a non-US
subsidiary, Innospec Performance Chemicals Italia Srl , is subject to an ongoing tax audit in relation to the period 2011 to 2014 inclusive. The Company has determined that additional tax, interest and penalties totaling $ 3.4 million may arise as a consequence of the tax audit. This includes a reduction in interest accrued of $ 0.2 million and an increase for foreign exchange movements of $ 0.2 million recorded during 2020. 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 indemnification asset of the same amount is recorded in the financial statements to reflect this arrangement.
As previously disclosed, in 2018 the Company recorded an unrecognized tax benefit in relation to a potential adjustment that could arise as a consequence of the Tax Act, but for
85
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
which retrospective adjustment to the filed 2017 U.S. federal income tax returns was not permissible. The Company has determined that additional tax, interest and penalties totaling $ 12.4 million may arise in relation to this item. This includes an increase in interest accrued of $ 0.7 million during 2020.
As previously disclosed, in 2015 the Company recorded an unrecognized tax benefit of $ 1.2 million in relation to additional tax that could have arisen if a historical impairment in value of certain of the Company’s non-U.S.
subsidiaries was reversed upon challenge by the tax authorities. During 2020, the Company released the provision of $ 1.2 million in full, together with accrued interest of $ 0.2 million thereon, following a review of the value of the Company’s investments that confirmed the historical impairment in value undertaken in 2005 was appropriate.
Other non-significant
items, inclusive of interest and penalties, total $ 0.2 million.
The Company and its U.S. subsidiaries remain open to examination by the IRS for years 2017 onwards under the statute of limitations. The Company’s subsidiaries in foreign tax jurisdictions are open to examination including Spain (2016 onwards), France (2017 onwards), Germany (2018 onwards), Switzerland (2018 onwards) and the U.K. (2018 onwards).
The sources of income before income taxes were as follows:
(in millions)
2020
2019
2018
Domestic
$
( 0.7
)
$
52.4
$
37.1
Foreign
40.4
98.0
94.5
$
39.7
$
150.4
$
131.6
The components of income tax expense are summarized as follows:
(in millions)
2020
2019
2018
Current:
Federal
$
6.1
$
13.8
$
12.5
State and local
0.5
2.3
2.0
Foreign
6.8
22.9
26.6
13.4
39.0
41.1
Deferred:
Federal
( 2.8
)
( 3.0
)
4.2
State and local
( 0.4
)
( 0.5
)
0.3
Foreign
0.8
2.7
1.0
( 2.4
)
( 0.8
)
5.5
$
11.0
$
38.2
$
46.6
86
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Cash payments for income taxes were $ 23.4 million, $ 37.6 million and $ 35.4 million during 2020, 2019 and 2018, respectively.
The effective tax rate varies from the U.S. federal statutory rate because of the factors indicated below:
(in percent)
2020
2019
2018
Statutory rate
21.0
%
21.0
%
21.0
%
Foreign income inclusions
7.1
0.3
0.7
Foreign tax rate differential
4.2
( 0.3
)
( 0.8
)
Tax charge/(credit) from previous
years
3.7
1.8
0.7
Net charge/(credit) from
unrecognized tax benefits
( 1.7
)
1.1
0.3
Foreign currency transactions
( 4.5
)
( 1.0
)
1.2
Effect of U.S. tax law change
0.0
0.6
9.3
Tax on unremitted earnings
0.3
( 0.1
)
0.9
Non-deductible
foreign interest
0.7
0.8
1.3
Change in UK statutory tax rate
6.9
0.0
0.0
State and local taxes
1.5
1.4
1.2
US incentive for foreign derived intangible income
( 1.5
)
( 0.5
)
( 1.0
)
Innovation incentives – current year
( 4.9
)
( 0.6
)
( 0.6
)
Innovation incentives – prior years
( 5.3
)
0.0
0.0
Non-deductible
officer compensation
1.8
0.2
0.4
Other items and adjustments, net
( 1.6
)
0.7
0.8
27.7
%
25.4
%
35.4
%
The mix of taxable profits generated in the different geographical jurisdictions in which the Group operates continues to have a significant impact on the effective tax rate. In 2020, a significant proportion of the Group’s profits were generated by non-U.S.
subsidiaries located in higher tax jurisdictions, which negatively impacted on the tax rate.
Foreign income inclusions arise each year from certain types of income earned overseas being taxable under U.S. tax regulations. Foreign tax credits can fully or partially offset these incremental U.S. taxes from foreign income inclusions. The utilization of foreign tax credits varies year on year as this is dependent on a number of variable factors which are difficult to predict and may prevent offset. The effective tax rate is negatively impacted by the net impact of foreign inclusions post foreign tax credit usage in 2020.
The 2020 effective tax rate was negatively impacted by the change in tax estimates for 2019 when compared to finalized positions as determined for the purpose of filing tax returns.
87
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
An increase in the enacted income tax rate in the UK on the Company’s deferred tax liabilities, which increased the 2020 tax charge by $ 2.7 million, had a negative impact on the effective tax rate.
The effective tax was also positively impacted by increased claims for innovation reliefs in the UK and the US. This reduced the tax charge in 2020 by $ 4.0 million.
As a consequence of the Company having operations
outside of the U.S., it is exposed to foreign currency fluctuations. These have a positive effect on the effective tax rate in 2020.
Other items do not have a material impact on the effective tax rate.
Details of deferred tax assets and liabilities are analyzed
as follows:
(in millions)
2020
2019
Deferred tax assets:
Stock compensation
$
5.3
$
6.7
Net operating loss carry forwards
9.8
7.3
Other intangible assets
10.6
6.0
Accretion expense
3.2
3.3
Restructuring provision
1.4
0.0
Foreign tax credits
2.0
3.6
Operating lease liabilities
9.2
7.4
Other
6.9
5.9
Subtotal
48.4
40.2
Less valuation allowance
( 1.1
)
( 0.8
)
Total net deferred tax assets
$
47.3
$
39.4
Deferred tax liabilities:
Property, plant and equipment
$
( 21.3
)
$
( 19.5
)
Intangible assets including goodwill
( 28.3
)
( 28.1
)
Pension asset
( 20.5
)
( 18.2
)
Investment impairment recapture
0.0
( 1.0
)
Customer relationships
( 4.4
)
( 4.2
)
Unremitted overseas earnings
( 2.0
)
( 1.0
)
Right-of-use assets
( 9.2
)
( 7.4
)
Other
( 0.9
)
( 0.5
)
Total deferred tax liabilities
$
( 86.6
)
$
( 79.9
)
Net deferred tax liability
$
( 39.3
)
$
( 40.5
)
Deferred tax assets
$
7.6
$
9.1
Deferred tax liabilities
( 46.9
)
( 49.6
)
$
( 39.3
)
$
( 40.5
)
88
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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, 2020. 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, 2020, a valuation allowance of $ 1.1 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.
Gross net operating loss carry forwards of $ 67.1 million result in a deferred tax asset of $ 8.7 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 $ 36.5 million arose in the U.S. It is expected that sufficient taxable profits will be generated in the U.S. against which $ 10.7 million of State net operating loss carry forwards can be relieved before their expiration in the period 2031 to 2040. The remaining U.S. State net operating losses and all U.S. Federal net operating losses can be carried forward indefinitely without expiration. Net operating loss carry forwards of $ 30.6 million arose in five of the Company’s foreign
subsidiaries, of which $ 1.3 million were generated in 2020
.
It is expected that sufficient taxable profits will be generated against which $ 24.4
million of these net operating loss carry forwards can be relieved. These losses can be carried forward indefinitely without expiration.
Note 12. Long-Term Debt
Long-term debt consists of the following:
(in millions)
2020
2019
Revolving credit facility
$
0.0
$
60.0
Term loan
0.0
0.0
Deferred finance costs
0.0
( 1.4
)
0.0
58.6
Less current portion
0.0
0.0
$
0.0
$
58.6
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.
89
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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.
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 current credit facility, as described below. 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.
(in millions)
2020
2019
Gross cost at January 1
$
1.5
$
2.7
Capitalized in the year
0.3
1.5
Written down in the year
0.0
( 2.7
)
1.8
1.5
Accumulated amortization at January 1
$
( 0.1
)
$
( 1.8
)
Amortization in the year
( 0.4
)
( 1.0
)
Amortization written down in the year
0.0
2.7
$
( 0.5
)
$
( 0.1
)
Net book value at December 31
$
1.3
$
1.4
Amortization expense was $ 0.4 million, $ 1.0 million and $ 0.7 million in 2020, 2019 and 2018, 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
90
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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, 2020 and does not expect to breach these covenants for the next 12 months.
The weighted average rate of interest on borrowings was 2.20 % at December 31, 2020 and 3.14 % at December 31, 2019. Payments of interest on long-term debt were $ 0.8 million, $ 4.8 million and $ 6.5 million in 2020, 2019 and 2018, respectively.
The net cash outflows in respect of refinancing costs were $ 0.3 million, $ 1.5 million and $ 0.0 million in 2020, 2019 and 2018, respectively.
Note 13. 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 Innospec’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:
(in millions)
2020
2019
2018
Total at January 1
$
49.3
$
49.5
$
46.1
Charge for the period excluding restructuring
5.1
4.4
6.8
Restructuring (see Note 5)
7.5
0.0
0.0
Utilized in the period
( 4.1
)
( 4.4
)
( 3.1
)
Exchange effect
0.7
( 0.2
)
( 0.3
)
Total at December 31
58.5
49.3
49.5
Due within one year
( 6.6
)
( 5.6
)
( 5.9
)
Due after one year
$
51.9
$
43.7
$
43.6
91
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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 2020 represents the accretion expense recognized of $ 3.7 million and a further $ 1.4 million primarily in respect of changes in the expected cost and scope of future remediation activities.
The Octane Additives segment ceased trading and is no longer a reporting segment from July 1, 2020. As a result, there has been a one-off
charge of $ 7.5 million for the restructuring activities related to the legacy production of TEL for use in motor gasoline.
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.
Remediation expenditure utilized provisions of $ 4.1 million, $ 4.4 million and $ 3.1 million in 2020, 2019 and 2018, respectively.
Note 14. 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 2019, 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.
92
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:
December 31, 2020
December 31, 2019
(in millions)
Carrying
Amount
Fair
Value
Carrying
Amount
Fair
Value
Assets
Non-derivatives:
Cash and cash equivalents
$
105.3
$
105.3
$
75.7
$
75.7
Derivatives (Level 1 measurement):
Other current and non-current
assets:
Foreign currency forward exchange contracts
0.0
0.0
0.8
0.8
Liabilities
Non-derivatives:
Long-term debt (including current portion)
$
0.0
$
0.0
$
58.6
$
58.6
Finance leases (including current portion)
0.6
0.6
1.5
1.5
Derivatives (Level 1 measurement):
Other
current
liabilities:
Foreign currency forward exchange contracts
0.5
0.5
0.0
0.0
Non-financial
liabilities (Level 3 measurement):
Stock equivalent units
17.2
17.2
24.6
24.6
The following methods and assumptions were used to estimate the fair values:
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 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.
93
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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 15. 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, 2020 and at December 31, 2019, there were no interest rate swaps in place with all swaps having been settled during 2019. Interest rate swaps were previously 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 interest rate swaps in the prior years were designated as hedging instruments, and their impact on other comprehensive loss for 2019 was a loss of $ 1.9 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, 2020, foreign currency forward exchange contracts with a notional value of $ 127.2 million were in place (December 31, 2019 $ 108.9 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 2020 was a loss of $ 1.5 million (2019 – gain $ 1.5 million).
As at December 31, 2020 and December 31, 2019 the Company did not hold any raw material derivatives.
The Company sells a range of specialty chemicals to major oil refiners 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 16. Commitments and Contingencies
Environmental remediation obligations
Commitments in respect of environmental remediation obligations are disclosed in Note 13
of the Notes to the Consolidated Financial Statements.
Capital commitments
The estimated additional cost to complete work in progress at December 31, 2020 is $ 14.7 million (2019 – $ 4.0 million).
94
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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, 2020, such guarantees which are not recognized as liabilities in the consolidated financial statements amounted to $ 9.9 million (December 31, 2019 – $ 4.7 million). The remaining terms of the fixed maturity guarantees vary from 1 month to 3 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 17. Stockholders’ Equity
Common Stock
Treasury Stock
(number of shares in thousands)
2020
2019
2018
2020
2019
2018
At January 1
29,554.5
29,554.5
29,554.5
5,047
5,121
5,204
Exercise of options
0
0
0
( 109
)
( 104
)
( 103
)
Stock purchases
0
0
0
21
30
20
At December 31
29,554.5
29,554.5
29,554.5
4,959
5,047
5,121
95
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
At December 31, 2020, the Company had authorized common stock of 40,000,000 shares (2019 – 40,000,000 ).
Note 18. Stock-Based Compensation Plans
Stock option plans
The Company has two stock option plans, the Omnibus Long-Term Incentive Plan and the ShareSave Plan 2008 under which it currently grants awards. The stock options have vesting periods ranging from 2 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 .
In the fourth quarter of 2020, a number of stock options that were granted to 14 employees in February 2018 were modified to extend the vesting period by two years . The incremental compensation cost resulting from the modifications was $ 2.4 million, resulting from the performance targets that were not achieved in 2020 being extended to a future period.
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:
2020
2019
2018
Dividend yield
1.18
%
1.09
%
1.11
%
Expected life
5 years
5 years
5 years
Volatility
27.0
%
26.8
%
25.6
%
Risk free interest rate
1.13
%
2.48
%
2.74
%
The following table summarizes the transactions of the Company’s stock option plans for the year ended December 31, 2020:
Number of
Options
Weighted
Average
Exercise
Price
Weighted
Average
Grant-Date
Fair Value
Outstanding at December 31, 2019
504,459
$
33.05
$
41.35
Granted – at discount
63,950
$
1.11
$
76.80
– at market value
10,419
$
95.70
$
18.69
Exercised
( 108,518
)
$
20.31
$
45.17
Forfeited
( 27,417
)
$
41.93
$
36.41
Outstanding at December 31, 2020
442,893
$
32.49
$
45.31
96
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
At December 31, 2020, there were 42,657 stock options that were exercisable, 15,611 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.
The stock option compensation cost for 2020, 2019 and 2018 was $ 5.8 million, $ 6.6 million and $ 4.9 million, respectively. The total intrinsic value of options exercised in 2020, 2019 and 2018 was $ 4.9 million, $ 3.5 million and $ 3.2 million, respectively.
The total compensation cost related to non-vested
stock options not yet recognized at December 31, 2020 was $ 6.8 million and this cost is expected to be recognized over the weighted-average period of 1.59 years.
In 2020, the Company recorded a current tax benefit of $ 1.6 million in respect of stock option compensation (2019 – $ 1.5 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 2 to 5 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, 2020 the liability for SEUs of $ 17.2 million is included in accrued liabilities in the consolidated balance sheets until they are cash settled.
In the fourth quarter of 2020, a number of SEUs that were granted to 61 employees in February 2018 were modified to extend the vesting period by two years .
The adjusted compensation cost resulting from the modifications has been recognised by the fair valuation at the balance sheet date based on the extended vesting period.
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:
2020
2019
2018
Dividend yield
1.15
%
0.99
%
1.44
%
Expected life
5 years
5 years
5 years
Volatility
39.9
%
26.6
%
27.2
%
Risk free interest rate
0.17
%
1.62
%
2.46
%
97
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table summarizes the transactions of the Company’s SEUs for the year ended December 31, 2020:
Number
of SEUs
Weighted
Average
Exercise
Price
Weighted
Average
Grant-Date
Fair Value
Outstanding at December 31, 2019
390,816
$
3.69
$
59.91
Granted – at discount
113,107
$
0.00
$
76.63
– at market value
3,634
$
95.70
$
18.69
Exercised
( 93,057
)
$
0.82
$
60.04
Forfeited
( 24,336
)
$
0.60
$
65.99
Outstanding at December 31, 2020
390,164
$
4.35
$
63.96
At December 31, 2020, there were 53,146 SEUs that were exercisable, 46,614 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 2020, 2019 and 2018 was $ 1.9 million, $ 20.1 million and $ 5.7 million, respectively. The total intrinsic value of SEUs exercised in 2020, 2019 and 2018 was $ 6.3 million, $ 7.3 million and $ 2.7 million, respectively.
The weighted-average remaining vesting period of non-vested
SEUs is 1.98 years.
Forfeits are accounted for as an adjustment to the charge in the period in which the forfeits occur.
Note 19. Reclassifications out of Accumulated Other Comprehensive Loss
Reclassifications out of accumulated other comprehensive loss for 2020 were:
(in millions)
Amount
Reclassified
from AOCL
Affected Line Item in the
Statement where
Net
Income is Presented
Details about AOCL Components
Defined benefit pension plan items:
Amortization of prior service credit
$
( 0.5
)
See (1) below
Amortization of actuarial net losses
1.7
See (1) below
1.2
Total before tax
( 0.1
)
Income tax expense
Total reclassifications
$
1.1
Net of tax
98
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(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.
Changes in accumulated other comprehensive loss for 2020, net of tax, were:
(in millions)
Defined
Benefit
Pension
Plan Items
Cumulative
Translation
Adjustments
Total
Balance at December 31, 2019
$
( 9.3
)
$
( 65.1
)
$
( 74.4
)
Other comprehensive income before reclassifications
0.0
23.7
23.7
Amounts reclassified from AOCL
1.1
0.0
1.1
Actuarial net gains arising during the year
( 7.7
)
0.0
( 7.7
)
Net current period other comprehensive income
( 6.6
)
23.7
17.1
Balance at December 31, 2020
$
( 15.9
)
$
( 41.4
)
$
( 57.3
)
Note 20. Recently Issued Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2019-12,
Simplifying the Accounting for Income Taxes (Topic 740). This removes certain exceptions to the general principles in Topic 740 and improves consistent application of and simplifies GAAP for other areas of Topic 740 by clarifying and amending existing guidance. This ASU is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years, with early adoption permitted. The Company will be applying this ASU from January 1, 2021. We are currently evaluating the impact of adopting this new accounting guidance on our consolidated financial statements, including accounting policies, processes and systems, but we do not expect adoption will have a material impact on the Company’s disclosures.
Note 21. Related Party Transactions
Mr. Patrick S. Williams has been an executive director of the Company since April 2009 and has been a non-executive
director of AdvanSix, a chemicals manufacturer, since February 2020. In 2020 the Company purchased product from AdvanSix for $ 0.3
million. As at December 31, 2020, the Company owed $ 0.0
million to AdvanSix.
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 2020, 2019 and 2018 the Company incurred fees payable to SGR of $ 0.8
million, $ 0.5
million and $ 0.3
million, respectively. As at December 31, 2020 the Company owed $ 0.1
million to SGR
(December 31, 2019 – $ 0.0 million).
99
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 2020 for a value of $ 0.2
million (2019 – $ 0.4
million; 2018 – $ 0.3
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, 2020 EMR owed $ 0.0
million (December 31, 2019 – $ 0.0
million).
Note 22. 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.
100
Item 9
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.