INNOSPEC INC. - Annual Report: 2020 (Form 10-K)

This Form contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts included or incorporated herein may constitute forward-looking statements. Such forward-looking statements include statements (covered by words like “expects,” “estimates,” “anticipates,” “may,” “could,” “believes,” “feels,” “plan,” “intend” or similar words or expressions, for example) which relate to earnings, growth potential, operating performance, events or developments that we expect or anticipate will or may occur in the future. Although forward-looking statements are believed by management to be reasonable when made, they are subject to certain risks, uncertainties and assumptions, including, the effects of the pandemic, such as its duration, its unknown long-term economic impact, measures taken by governmental authorities to address it and the manner in which the pandemic may precipitate or exacerbate other risks and/or uncertainties, and our actual performance or results may differ materially from these forward-looking statements. You are urged to review our discussion of risks and uncertainties that could cause actual results to differ from forward-looking statements under the heading “Risk Factors.” Innospec undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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 has ceased trading and is no longer a reporting segment from July 1, 2020, as reported in our Quarterly Report on Form for the quarter ended June 30, 2020.

This segment had been growing strongly in recent years until the pandemic adversely impacted customer demand in 2020. We expect increased customer activity to return as the global demand for fuel increases and oil prices return to the levels.

The trademark “Innospec and the Innospec device” in Classes 1, 2 and 4 of the “International Classification of Goods and Services for the Purposes of the Registration of Marks” are registered in all jurisdictions in which the Company has a significant market presence. The Company also has trademark registrations for certain product names in all jurisdictions in which it has a significantmarket presence.

Fuel Specialties is generally characterized by a small number of competitors, none of which hold a dominant position. We consider our competitive edge to be our proven technical development capacity, independence from major oil companies and strong long-term customer relationships. We believe we remain the world’s only producer of TEL for use in aviation gasoline, which we market as our AvTel product line.

Within the Performance Chemicals segment we operate in the Personal Care, Home Care, Agrochemical and Metal Extraction markets which are highly fragmented, and the Company experiences substantial competition from a large number of multinational and specialty chemical suppliers in each geographical market. Our competitive position in these markets is based on us supplying a superior, diverse product portfolio which solves particular customer problems or enhances the performance of new or existing products. In a number of specialty chemicals markets, we also supply niche product lines, where we enjoy market-leading positions.

Our Oilfield Services segment is very fragmented and although there are a small number of very large competitors, there are also a large number of smaller players focused on specific technologies or regions. Our competitive strength is our proven technology, broad regional coverage and strong customer relationships.

Production and sales of TEL for use in automotive gasoline have ceased and therefore Octane Additives is no longer a reporting segment from July 1, 2020.

Our corporate web site is . We make available, free of charge, on or through this web site our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such material with, or furnishing it to, the U.S. Securities and Exchange Commission (“SEC”). In addition, the SEC maintains an internet site at that contains reports, proxy and information statements, and other information that we file electronically with the SEC and state the address of that site.

The Company routinely posts important information for investors on its web site (under Investors). The Company uses this web site as a means of disclosing material, information and for complying with its disclosure obligations under SEC Regulation FD (“Fair Disclosure”). Accordingly, investors should monitor the Investors portion of the Company’s web site, in addition to following the Company’s press releases, SEC filings, public conference calls, presentations and webcasts.

We have been closely monitoring the impact of the pandemic on all aspects of our business, including how it has and will impact our customers, employees, supply chain, and distribution network. The effects of on the global economic environment have impacted, and are expected to continue to impact, the results of the Company significantly, particularly with respect to reduced demand within our Fuel Specialties and Oilfield Services segments, and we are unable to predict the ultimate impact that it may have on our business, future results of operations, financial position or cash flows. The further extent to which our operations may be impacted by the pandemic will depend largely on future developments, which are highly uncertain and cannot be accurately predicted. These include, but are not limited to, the availability and productivity of our employees, the duration and severity of the pandemic; government restrictions on businesses and individuals; the impact of the pandemic on our customers’ businesses and the resulting demand for our products; the impact on our suppliers and supply chain network; the impact on global economies, including the possibility of recession and depression, and the timing and rate of economic recovery; the development of treatments and vaccines; and potential adverse effects on the financial markets.

The impact of as well as future pandemics or resurgences, may also exacerbate other risks discussed herein, any of which could have a material effect on us. This situation is changing rapidly and additional impacts that may occur are currently unknown.

In certain markets, our competitors are larger than us and may have greater access to financial, technological and other resources. As a result, competitors may be better able to adapt to changes in conditions in our industries, fluctuations in the costs of raw materials or changes in global economic conditions. Competitors may also be able to introduce new products with enhanced features that may cause a decline in the demand and sales of our products. Consolidation of customers or competitors, or economic problems of customers in our markets could cause a loss of market share for our products, place downward pressure on prices, result in payment delays or or declining plant utilization rates. These risks could adversely impact our results of operations, financial position and cash flows.

in most respects, as if it were still a member of the E.U., and generally remained subject to E.U. law. On December 24, 2020, the E.U. and the U.K. reached an agreement in principle on the terms of certain agreements and declarations governing the ongoing relationship between the E.U. and the U.K., including the Trade and Cooperation Agreement (the “Agreement”). The Agreement itself is limited in its scope to primarily the trade of goods, transport, energy links and fishing, and uncertainties remain relating to certain aspects of the U.K.’s future economic, trading and legal relationships with the E.U. and with other countries. The departure of the U.K. from the E.U. Single Market and Customs Union (as well as all E.U. policies and international agreements) has ended free movement of goods between the U.K. and the E.U., creating and quota barriers (such as customs checks at the borders between the E.U. and the U.K.) to trade in goods, resulting in increased disruption and cost to businesses and requiring adjustments to integrated E.U.- U.K. supply chains. Moreover, the free movement of persons, services and capital between the U.K. and the E.U. ended on January 1, 2021, which has meant the loss for U.K. suppliers of services of their automatic right to offer such services across the E.U..

Demand for all of our products may be adversely impacted by the continuing impact of the pandemic which will continue to create uncertainty in the markets in 2021 and possibly beyond.

We rely on information technology systems to transact our business. Like other global companies, we have, from time to time, experienced threats to our data and systems. Although we have implemented administrative and technical controls and take protective actions to reduce the risk of cyber incidents and breaches of our information technology, and we endeavor to modify such procedures as circumstances warrant, such measures may be insufficient to prevent physical and electronic cyber-attacks or other security breaches to our computer systems.

The continued sales of TEL for use in aviation fuel (“AvTel”) are recorded within our Fuel Specialties business. The piston aviation industry has been, and is currently, researching a safe replacement fuel to replace leaded fuel. The Federal Aviation Administration program (Piston Aviation Fuels Initiative) has been established to identify a replacement and candidate fuels are at an early stage. This process is currently suspended and anticipated to restart in 2021. The timescale beyond this stage is unclear, but the full testing program will, of necessity, be long and comprehensive.

Prices for oil and gas are subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and gas, market uncertainty, and a variety of other economic and political factors that are beyond our control. Even the perception of longer-term lower oil and gas prices by oil and gas companies can similarly reduce or defer major expenditures given the long-term nature of many large-scale development projects. Factors affecting the prices of oil and gas include the level of supply and demand for oil and gas, governmental regulations, including the policies of governments regarding the exploration for and production and development of their oil and gas reserves, weather conditions and natural disasters, worldwide political, military, and economic conditions, the level of oil and gas production by (“Organization of the Petroleum Exporting Countries”) countries and the available excess production capacity within OPEC, the cost of producing and delivering oil and gas and potential acceleration of the development of alternative power generation, fuels and engine technologies. Any prolonged reduction in oil and gas prices will depress the immediate levels of exploration, development, and production activity which could have a material adverse impact on our results of operations, financial position and cash flows.

Our principal customers are oil and gas exploration and production companies, oil refiners, personal care companies, and other chemical and industrial companies. These industries are characterized by a concentration of a few large participants. The loss of a significant customer, a material reduction in demand by a significant customer or termination or of a significant customer contract could adversely impact our results of operations, financial position and cash flows.

We sell products to oil companies, oil and gas exploration and production companies and chemical companies throughout the world. Credit limits, ongoing credit evaluation and account monitoring procedures are used to minimize bad debt risk. Collateral is not generally required. We have in place a credit facility with a syndicate of banks. From time to time, we use derivatives, including interest rate swaps, commodity swaps and foreign currency forward exchange contracts, in the normal course of business to manage market risks. We enter into derivative instruments with a diversified group of major financial institutions in order to manage the exposure to of such instruments.

We remain subject to market and credit risks including the ability of counterparties to meet their contractual obligations and the potential of counterparties to deliver contracted commodities or services at the contracted price. The inability of counterparties to meet their contractual obligations could have an adverse impact on our results of operations, financial position and cash flows.

Our amended and restated (the provide that, unless we consent in writing to the selection of an alternative forum, the appropriate court within the State of Delaware is the sole and exclusive forum, to the fullest extent provided by law, for the following types of actions or proceedings:

This forum selection provision in the may limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us. It is also possible that, notwithstanding the forum selection clause included in the a court could rule that such a provision is inapplicable or unenforceable.

(“EBITDA”) and net interest expense to EBITDA. Net debt, net interest expense and EBITDA are measures of liquidity defined in the credit facility. Our ability to meet these financial covenants depends upon the future successful operating performance of the business. If we fail to comply with financial covenants, we would be in default under the revolving credit facility and the maturity of our outstanding debt could be accelerated unless we were able to obtain waivers from our lenders. If we were found to be in default under the revolving credit facility, it could adversely impact our results of operations, financial position and cash flows.

The graph below compares the cumulative total return to stockholders on the common stock of the Corporation, S&P 500 Index, NASDAQ Composite Index and Russell 2000 Index since December 31, 2015, assuming a $100 investment and the of any dividends thereafter. Historical stock price performance should not be relied upon as an indication of future stock price performance.

For much of 2020, customer demand was adversely impacted by the pandemic and the unprecedented collapse in demand for crude oil. The low point of the year for the decline in customer demand was the second quarter and all of our businesses have been showing some recovery since that time, although they have not yet returned to levels.

If a quantitative test is required, we assess the fair value based on projected cash flows discounted at the Company’s weighted average cost of capital. These fair value techniques require management judgment and estimates including revenue growth rates, projected operating margins, changes in working capital and discount rates. We would develop these assumptions by considering recent financial performance and trends and industry growth estimates. While we believe our assumptions for impairment assessments are reasonable, they are subjective judgments, and it is possible that variations in any of the assumptions will result in materially different calculations of any potential impairment charges.

At December 31, 2020 we had $371.2 million of goodwill relating to our Fuel Specialties, Performance Chemicals and Oilfield Services segments. Due to the triggering events of the pandemic and the reduction in oil prices and their impact on our business, we performed a step one impairment review at June 30, 2020. The impairment assessment indicated the fair values substantially exceeded the carrying values for all operating segments. Despite this, due to a significant downturn in one of the entities, we performed a further assessment of the intangible assets of that entity, which resulted in an impairment of $19.8 million at June 30, 2020.

The Company’s results have been adversely impacted in 2020, due to the pandemic and the global economic environment.

Fuel Specialties have been impacted by reduced demand stemming from the reduction in freight transport and passenger miles and the widespread grounding of aircraft for a large part of the year. We have seen some improvement in the fourth quarter as travel has begun to increase, but demand has not returned to the levels. We expect demand will continue to improve in 2021, to the extent global economic activity recovers, subject to the continuation of the current lockdowns in Europe in particular and the potential for future lockdowns or restrictions around the world related to the spread of new COVID variants.

Oilfield Services have been heavily impacted by the reduction in oil exploration and production as the wider industry reacts to the reduction in demand and low oil price. We have seen some improvement in the second half of the year from increasing demand and the benefit from the reduction in headcount that occurred in the second quarter. We do not know how long this downturn will last and the rate of recovery will depend heavily on the rate and extent to which the government restrictions on movement are lifted and not

the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:

Volumes in all our regions have suffered from the adverse impact of the pandemic, which has reduced the global demand for fuel additive products. During the second half of 2020, we have seen customer demand recovering steadily as lockdowns in countries around the world have been eased. However, the reintroduction of lockdowns for European countries in January 2021 could slow the return of customer demand to the level. Price and product mix in all our regions was adverse due to lower sales of our higher margin products. AvTel volumes were higher than the prior year due to variations in the demand from customers, being offset by an adverse price and product mix. EMEA benefitted from favorable exchange rate movements year over year, due to a strengthening of the British pound sterling and the European Union euro against the U.S. dollar.

the year over year decrease of 3.7 percentage points was driven by the impact of the pandemic reducing demand for our higher margin products, together with adverse raw material costs and higher provisions for slow moving inventory.

the year over year decrease of $12.1 million was due to cost savings as a result of the pandemic, including lower travel and entertainment costs, together with lower personnel related performance-based remuneration due to a decrease in share-based compensation accruals linked to the Innospec share price.

the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:

the year over year increase of 1.1 percentage points was due to a richer sales mix, the continued benefit of margin improvement projects and the timing of pricing movements for certain raw materials.

the year over year decrease of $2.4 million was driven by lower personnel related performance-based remuneration due to a decrease in the share-based compensation accruals linked to the Innospec share price, together with cost savings as a result of the pandemic, including lower travel and entertainment costs.

the year over year decrease of $224.9 million, or 47 percent, was primarily due to a collapse of customer activity for the U.S. onshore market, as a result of the pandemic reducing world-wide demand together with the depressed price of crude oil. The previously expected recovery in the U.S. completions market has been delayed, however the Company has seen an improvement in the demand for crude oil in the second half of 2020 leading to higher sales for our production and drag reducing agent products.

the year over year decrease of 1.6 percentage points was primarily due to significant inventory adjustments in the second quarter of 2020 as a result of the collapse in demand, being partly offset by margin improvements in the second half of the year due to a favorable sales mix and management cost control initiatives.

the year over year decrease of $29.9 million was driven by the of the operations to adjust for the reduction in demand caused by the pandemic, together with lower accruals for long-term performance-based incentive plans due to a decrease in share-based compensation accruals linked to the Innospec share price.

the year over year decrease of $2.2 million was driven by lower accruals for long-term performance-based incentive plans due to the impact of the pandemic on the group’s profit performance together with a decrease in the share-based compensation accruals linked to the Innospec share price. There has also been a reduction in travel and entertainment expenses resulting from the pandemic restrictions on local and international travel. The decrease in costs was partly offset by $4.2 million of acquisition related costs in 2020; the inclusion of legacy costs related to the now closed Octane Additives segment of $2.5 million; and higher spending on information technology following the network security incident in the second quarter of 2019.

was $21.3 million related to the cessation of production and sales of TEL for use in motor gasoline. See Note 5 of the Notes to the Condensed Consolidated Financial Statements for further information.

was $19.8 million related to acquired intangible assets in our Oilfield Services segment. See Note 9 of the Notes to the Condensed Consolidated Financial Statements for further information.

for 2020 and 2019, includes the following:

was $1.8 million for 2020 compared to $4.8 million in the prior year, driven by lower average net debt as the business generated cash inflows.

The effective tax rate was 27.7% and 25.4% in 2020 and 2019, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 23.5% in 2020 compared with 22.6% in 2019. The Company believes that this adjusted effective tax rate, a financial measure, provides useful information to investors and may assist them in evaluating the Company’s underlying performance and identifying operating trends. In addition, management uses this financial measure internally to evaluate the performance of the Company’s operations and for planning and forecasting in subsequent periods.

the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:

the year on year increase of 1.1 percentage points benefitted from an improvement in the mix of product sales.

the year on year increase of $9.2 million was driven by increased selling expenses including higher agents’ commissions and higher personnel related performance-based remuneration due to increased share-based compensation accruals.

the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:

Lower volumes in the Americas and EMEA were driven by a customer taking some volume Higher volumes in ASPAC were driven by increased demand for our Personal Care products, partly offset by an adverse price and product mix. Price and product mix in the Americas benefitted from increased sales of higher margin products, while EMEA was adversely impacted by lower raw material prices driving lower selling prices for certain products. EMEA and ASPAC were negatively impacted by exchange rate movements year over year, due to a weakening of the British pound sterling and the European Union euro against the U.S. dollar.

the year on year increase of 2.5 percentage points was driven by an improved sales mix, lower raw material prices and the continued benefit of several improvement projects.

the year on year decrease of $1.4 million was primarily due to the benefit of a weaker European Union euro against the U.S. dollar and lower costs as a result of the closure of our operation in Belgium in the prior year.

the year on year increase of $79.3 million, or 20 percent, was due to improved customer activity in stimulation and production driving increased demand for our technology and customer service. Sales of higher margin products have benefited the price and product mix.

the year on year increase of 0.7 percentage points was due to an improved customer and product mix leading to increased sales of higher margin products.

the year on year increase of $11.9 million was driven by higher selling and technical support expenses required to deliver the increase in customer demand.

were $21.0 million for 2019 compared to $33.7 million in 2018. Reduced sales are in line with our expectations as the one remaining customer moves closer to completing their transition to unleaded fuel.

the year on year decrease of 27.8 percentage points was due to lower production volumes spread over the predominantly fixed cost of manufacturing operations.

the year on year increase of $0.2 million was principally due to higher provisions for personnel related performance-based remuneration.

the year on year increase of $2.0 million primarily relates to higher personnel related performance-based remuneration including higher share-based compensation accruals; partly offset by a reduction for the amortization of our internally developed software following the completed amortization of our first deployment to the Americas which ended in the third quarter of 2018, together with the benefit of a weakening of the British pound sterling against the U.S. dollar for our United Kingdom cost base.

there was no charge in 2019 compared to a charge of $7.1 million in the prior year related to the closure costs, including redundancies and onerous leases, for our operation in Belgium.

for 2019 and 2018, includes the following:

was $4.8 million for 2019 compared to $6.9 million in the prior year, driven by lower average net debt as the business generated cash inflows.

The effective tax rate was 25.4% and 35.4% in 2019 and 2018, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 22.6% in 2019 compared with 23.7% in 2018. The Company believes that this adjusted effective tax rate, a financial measure, provides useful information to investors and may assist them in evaluating the Company’s underlying performance and identifying operating trends. In addition, management uses this financial measure internally to evaluate the performance of the Company’s operations and for planning and forecasting in subsequent periods.