UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-13879
INNOSPEC INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
8310 South Valley Highway
Suite 350
Englewood
Colorado
Registrant’s telephone number, including area code: (303) 792 5554
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such file. Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Common stock, par value $0.01 per share
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Common Stock, par value $0.01
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
Item 1
Condensed Consolidated Financial Statements
Condensed Consolidated Statements of Income
Condensed Consolidated Statements of Comprehensive Income
Condensed Consolidated Balance Sheets
Condensed Consolidated Balance Sheets (continued)
Condensed Consolidated Statements of Cash Flows
Condensed Consolidated Statement of Equity
Notes To The Unaudited Interim Condensed Consolidated Financial Statements
Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations for the Three Months Ended March 31, 2019
Critical Accounting Estimates
Results of Operations
Liquidity and Financial Condition
Item 3
Quantitative and Qualitative Disclosures about Market Risk
Item 4
Controls and Procedures
PART II
OTHER INFORMATION
Legal Proceedings
Item 1A
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5
Other Information
Item 6
Exhibits
SIGNATURES
CAUTIONARY STATEMENT RELATIVE TO FORWARD-LOOKING STATEMENTS
This Form 10-Q 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,” “believes,” “feels” 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, and our actual performance or results may differ materially from these forward-looking statements. Additional information regarding risks, uncertainties and assumptions relating to Innospec and affecting our business operations and prospects are described in Innospec’s Annual Report on Form 10-K for the year ended December 31, 2018 and other reports filed with the U.S. Securities and Exchange Commission. 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” in such reports. Innospec undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
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PART I FINANCIAL INFORMATION
Item 1 Condensed Consolidated Financial Statements
INNOSPEC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(in millions, except share and per share data)
Net sales
Cost of goods sold
Gross profit
Operating expenses:
Selling, general and administrative
Research and development
Total operating expenses
Operating income
Other income, net
Interest expense, net
Income before income tax expense
Income tax expense
Net income
Earnings per share:
Basic
Diluted
Weighted average shares outstanding (in thousands):
The accompanying notes are an integral part of these unaudited interim condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
Other comprehensive (loss)/income:
Changes in cumulative translation adjustment, net of tax of $0.4 million and $(0.1) million respectively
Changes in unrealized gains on derivative instruments, net of tax of $0.1 million and $(0.2) million respectively
Amortization of prior service credit, net of tax of $0.0 million and $0.1 million respectively
Amortization of actuarial net losses, net of tax of $0.0 million and $(0.1) million respectively
Total other comprehensive (loss)/income
Total comprehensive income
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CONDENSED CONSOLIDATED BALANCE SHEETS
Assets
Current assets:
Cash and cash equivalents
Trade and other accounts receivable (less allowances of $3.5 million and $2.9 million respectively)
Inventories (less allowances of $14.0 million and $13.6 million respectively):
Finished goods
Raw materials
Total inventories
Prepaid expenses
Prepaid income taxes
Other current assets
Total current assets
Net property, plant and equipment
Goodwill
Operating leaseright-of-use assets
Other intangible assets
Deferred tax assets
Pension asset
Other non-current assets
Total assets
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CONDENSED CONSOLIDATED BALANCE SHEETS - (Continued)
Liabilities and Equity
Current liabilities:
Accounts payable
Accrued liabilities
Current portion of long-term debt
Current portion of finance leases
Current portion of plant closure provisions
Current portion of accrued income taxes
Current portion of operating lease liabilities
Total current liabilities
Long-term debt, net of current portion
Finance leases, net of current portion
Plant closure provisions, net of current portion
Accrued income taxes, net of current portion
Unrecognized tax benefits, net of current portion
Operating lease liabilities, net of current portion
Deferred tax liabilities
Pension liabilities and post-employment benefits
Other non-current liabilities
Total liabilities
Equity:
Common stock, $0.01 par value, authorized 40,000,000 shares, issued 29,554,500 shares
Additional paid-in capital
Treasury stock (5,074,700 and 5,120,799 shares at cost, respectively)
Retained earnings
Accumulated other comprehensive loss
Total Innospec stockholders’ equity
Non-controlling interest
Total equity
Total liabilities and equity
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows from Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Deferred tax expense
Cash contributions to defined benefit pension plans
Non-cash movements on defined benefit pension plans
Stock option compensation
Changes in assets and liabilities, net of effects of acquired and divested companies:
Trade and other accounts receivable
Inventories
Accounts payable and accrued liabilities
Accrued income taxes
Plant closure provisions
Unrecognized tax benefits
Other assets and liabilities
Net cash provided by/(used in) operating activities
Cash Flows from Investing Activities
Capital expenditures
Internally developed software
Net cash used in investing activities
Cash Flows from Financing Activities
Repayments of revolving credit facility
Repayments of finance leases
Issue of treasury stock
Repurchase of common stock
Net cash used in financing activities
Effect of foreign currency exchange rate changes on cash
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Amortization of deferred finance costs of $0.2 million (2018 – $0.1 million) are included in depreciation and amortization in the condensed consolidated statement of cash flow but in interest expense in the condensed consolidated statement of income.
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CONDENSED CONSOLIDATED STATEMENT OF EQUITY
Balance at December 31, 2018
Changes in cumulative translation adjustment, net of tax
Changes in unrealized gains on derivative instruments, net of tax
Treasury stock reissued
Treasury stock repurchased
Amortization of prior service credit, net of tax
Amortization of actuarial net losses, net of tax
Balance at March 31, 2019
Balance at December 31, 2017
Balance at March 31, 2018
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NOTES TO THE UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X under the Securities Exchange Act of 1934. Accordingly, they do not include all the information and notes necessary for a comprehensive presentation of financial position, results of operations and cash flows.
It is our opinion, however, that all adjustments (consisting of normal, recurring adjustments, unless otherwise disclosed) have been made which are necessary for the condensed consolidated financial statements to be fairly stated. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 filed on February 20, 2019 (the “2018 Form 10-K”).
The results for the interim period covered by this report are not necessarily indicative of the results to be expected for the full year.
When we use the terms “Innospec,” “the Corporation,” “the Company,” “Registrant,” “we,” “us” and “our,” we are referring to Innospec Inc. and its consolidated subsidiaries unless otherwise indicated or the context otherwise requires.
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 to not apply the requirements to short-term leases and have taken the election to not separate related non-lease components from lease components.
The standard had a material impact on our consolidated balance sheet, but did not have an impact on our consolidated income statement. 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 condensed consolidated balance sheet at March 31, 2019. The carrying value of assets under finance leases is included in property, plant and equipment and finance lease liabilities (current and non-current) on our consolidated balance sheet at March 31, 2019.
Operating lease ROU assets and operating lease liabilities are recognized based on the present value of future lease payments over the remaining lease term. Very few of our leases have renewal
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options or early termination break clauses, but where they do we have assessed the term of the lease based on any options being exercised only if they are reasonably certain. As most of our leases do not provide an implicit interest rate, we use our incremental borrowing rate based on the information available at point of recognition in determining the present value of future payments.
The operating lease ROU asset excludes lease incentives and initial direct costs incurred. Lease expense for lease payments is recognized on a straight-line basis over the lease term unless payments are variable per the agreement. Where we have lease payments linked to an index or inflationary rate, this rate has been used to value the asset and liability at the inception of the lease. If the payments are not linked to a specific index or inflationary rate, but can vary during the term of the agreement, they have been included at their actual value for each future period. In some circumstances the future expected payments may be dependent on other factors, for example production volumes, in which case we have used the minimum future expected payments to value the asset.
We do not recognize a ROU asset or operating lease liability for short-term leases (with a length of one year or less), and any associated cost is recognized, as incurred, through the income statement.
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NOTE 2 – SEGMENT REPORTING
The Company reports its financial performance based on the following four reportable: segments Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives.
The Fuel Specialties, Performance Chemicals and Oilfield Services segments operate in markets where we actively seek growth opportunities although their ultimate customers are different. The Octane Additives segment is expected to decline in the near future as our one remaining refinery customer transitions to unleaded fuel.
The Company evaluates the performance of its segments based on operating income. The following tables analyze sales and other financial information by the Company’s reportable segments:
Net Sales:
Refinery and Performance
Other
Fuel Specialties
Personal Care
Home Care
Performance Chemicals
Oilfield Services
Octane Additives
Gross profit:
Operating income/(loss):
Corporate costs
Total operating income
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The following table presents a summary of the depreciation and amortization charges incurred by the Company’s reportable segments:
Depreciation:
Corporate
Amortization:
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NOTE 3 – 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:
Numerator (in millions):
Net income available to common stockholders
Denominator (in thousands):
Weighted average common shares outstanding
Dilutive effect of stock options and awards
Denominator for diluted earnings per share
Net income per share, basic:
Net income per share, diluted:
In the three months ended March 31, 2019, the average number of anti-dilutive options excluded from the calculation of diluted earnings per share were 12,539 (three months ended March 31, 2018 – 18,468).
NOTE 4 – 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 1 year to 12 years and some of which include options to terminate the leases within 1 year.
The components of lease expense were as follows:
Finance lease cost:
Amortization ofright-of-use assets
Interest on lease liabilities
Total finance lease cost
Operating lease cost
Short-term lease cost
Variable lease cost
Sub-lease income
Total lease cost
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Supplemental cash flow information related to leases was as follows:
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
Operating cash flows from finance leases
Financing cash flows from finance leases
Right-of-useassets obtained in exchange for new lease obligations:
Operating leases
Finance leases
Supplemental balance sheet information related to leases was as follows:
(in millions except lease term and discount rate)
Operating leases:
Total operating lease liabilities
Finance leases:
Property, plant and equipment at cost
Accumulated depreciation
Total finance lease liabilities
Weighted average remaining lease term:
Weighted average discount rate:
Maturities of lease liabilities were as follows:
Within one year
Year two
Year three
Year four
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Year five
Thereafter
Total lease payments
Less imputed interest
Total
As of March 31, 2019, additional operating and finance leases that have not yet commenced are $0.0 million.
NOTE 5 – GOODWILL
The following table summarizes goodwill at the balance sheet dates:
At December 31, 2018
Gross cost (1)
Accumulated impairment losses
Net book amount
Exchange effect
At March 31, 2019
Gross cost for 2019 and 2018 is net of $298.5 million of historical accumulated amortization.
NOTE 6 – OTHER INTANGIBLE ASSETS
The following table summarizes the other intangible assets movement year on year:
Gross cost at January 1
Gross cost at March 31
Accumulated amortization at January 1
Amortization expense
Accumulated amortization at March 31
Net book amount at March 31
Internally developed software has been capitalized in relation to the Company’s information system platforms.
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Product rights
Brand names
Technology
Customer relationships
NOTE 7 – PENSION AND POST EMPLOYMENT BENEFITS
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 net service cost for the three months ended March 31, 2019 was $0.2 million (three months ended March 31, 2018 – $0.3 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:
Plan net pension credit/(charge):
Interest cost on projected benefit obligation
Expected return on plan assets
Amortization of prior service credit
Amortization of actuarial net losses
The amortization of prior service credit and actuarial net losses is a reclassification out of accumulated other comprehensive loss into other income and expense.
The Company also maintains an unfunded defined benefit pension plan covering a number of its current and former employees in Germany (the “German plan”) within our Fuel Specialties segment. The German plan is closed to new entrants and has no assets. The net service cost for the German plan for the three months ended March 31, 2019 was $0.0 million (three months ended March 31, 2018 - $0.0 million). The following table shows the income statement effect recognized within other income and expense:
Plan net pension charge:
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As at March 31, 2019, our Performance Chemicals segment has obligations for post-employment benefits in its European businesses with a liability of $4.4 million (December 31, 2018 - $4.4 million).
NOTE 8 – INCOME TAXES
A roll-forward of unrecognized tax benefits and associated accrued interest and penalties is as follows:
Opening balance at January 1
Additions for tax positions of prior periods
Closing balance at March 31
Current
Non-current
We recognize accrued interest and penalties associated with unrecognized tax benefits as part of income taxes in our condensed consolidated statements of income. Related to the unrecognized tax benefits noted above, we have also accrued a net increase in interest and penalties of $0.2 million during the first three months of 2019, and a net increase in interest and penalties of $0.3 million in 2018. Total accrued interest and penalties at March 31, 2019 on all remaining unrecognized tax benefits amounted to $0.8 million (December 31, 2018 – $0.6 million).
All of the $14.2 million of unrecognized tax benefits, interest and penalties, would impact our effective tax rate if recognized.
As previously disclosed, tax audits have been opened by the Italian tax authorities in respect of Innospec Performance Chemicals Italia Srl, acquired as part of the Huntsman business, in relation to the period 2011 to 2013 inclusive. The Company believes that additional tax of approximately $0.5 million, together with associated interest of $0.2 million, may arise as a result of the 2011 audit. These amounts were recorded at December 31, 2017. During 2018, the Company determined that additional tax of approximately $0.9 million, together with associated interest of $0.3 million, may arise as a result of the 2012 and 2013 audits collectively. As any additional tax arising as a consequence of the tax audit would be reimbursed by the previous owner under the terms of the sale and purchase agreement, an unrecognized tax benefit of $1.9 million is recorded, together with an indemnification asset of the same amount to reflect the fact that the final liability would be reimbursed by the previous owner.
In the fourth quarter of 2018, the Company recorded an unrecognized tax benefit of $10.8 million. This portion primarily relates to a potential adjustment that could arise as a consequence of the Tax Cuts and Jobs Act, but for which retrospective adjustment to the filed 2017 U.S. federal income tax returns was not permissible. The Company accrued a net increase in interest of $0.2 million in the first three months of 2019 relating to this matter.
The Company and its U.S. subsidiaries remain open to examination by the IRS for years 2015 onwards under the statute of limitations. The Company’s subsidiaries in foreign tax jurisdictions are open to examination including Spain (2014), France (2016 onwards), Germany (2014 onwards), Switzerland (2014 onwards) and the United Kingdom (2017 onwards).
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NOTE 9 – LONG-TERM DEBT
Long-term debt consists of the following:
Revolving credit facility
Term loan
Deferred finance costs
Due within one year
Due after one year
NOTE 10 – PLANT CLOSURE PROVISIONS
The liability for estimated closure costs of Innospec’s manufacturing facilities includes costs for decontamination and environmental remediation activities (“remediation”). The principal site giving rise to remediation liabilities is the manufacturing site at Ellesmere Port in the United Kingdom. There are also remediation liabilities on a smaller scale in respect of our other manufacturing sites in the U.S. and the rest of Europe.
Movements in the provisions are summarized as follows:
Total at January 1
Charge for the period
Utilized in the period
Total at March 31
Amounts due within one year refer to provisions where expenditure is expected to arise within one year of the balance sheet date.
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NOTE 11 – FAIR VALUE MEASUREMENTS
The following table presents the carrying amount and fair values of the Company’s financial assets and liabilities measured on a recurring basis:
Non-derivatives:
Derivatives (Level 1 measurement):
Other current and non-current assets:
Foreign currency forward exchange contracts
Interest rate swaps
Liabilities
Long-term debt (including current portion)
Finance leases (including current portion)
Other current and non-current liabilities:
Non-financial liabilities (Level 3 measurement):
Stock equivalent units
The following methods and assumptions were used to estimate the fair values of financial instruments:
Cash and cash equivalents and bank overdraft: The carrying amount approximates fair value because of the short-term maturities of such instruments.
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 relate to contracts taken out to hedge interest rate risk on a portion of our credit facilities borrowing.
Long-term debt and finance leases: Long-term debt principally comprises the term loan and revolving credit facility, which are shown net of deferred finance costs that have been capitalized. The fair value of long-term debt approximates to the carrying value, as the discounting to its present value is offset by the interest rate swaps. 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.
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 depending on the terms of each grant.
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NOTE 12 – DERIVATIVE INSTRUMENTS AND RISK MANAGEMENT
The Company enters into various foreign currency forward exchange contracts to minimize currency exchange rate exposure from expected future cash flows. As at March 31, 2019, the contracts have maturity dates of up to twelve months at 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 the first three months of 2019 was a gain of $0.2 million (first three months of 2018: loss of $0.5 million).
The Company enters into interest rate swaps to minimize interest rate exposure related to a part of our borrowing requirements. These interest rate swaps have been designated as hedging instruments, and their impact on accumulated other comprehensive loss for the first three months of 2019 was a loss of $0.7 million (first three months of 2018: gain of $1.1 million).
NOTE 13 – COMMITMENTS AND 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 claims or proceedings could in the aggregate have a material adverse effect on the 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 March 31, 2019, such guarantees which are not recognized as liabilities in the condensed consolidated financial statements amounted to $4.6 million.
Under the terms of the guarantee arrangements, generally the Company would be required to perform should the affiliated company fail to fulfil 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 14 – STOCK-BASED COMPENSATION PLANS
The Company grants stock options and stock equivalent units (“SEUs”) from time to time as a long-term performance incentive. In certain cases the grants are subject to performance conditions such as the Company’s stock price. Where performance conditions apply the Monte Carlo simulation model is used to determine the fair values. Otherwise the Black-Scholes model is used to determine the fair values.
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Stock option plans
The following table summarizes the transactions of the Company’s stock option plans for the three months ended March 31, 2019:
Outstanding at December 31, 2018
Granted - at discount
- at market value
Exercised
Forfeited
Outstanding at March 31, 2019
At March 31, 2019, there were 45,170 stock options that were exercisable, of which 6,592 had performance conditions attached.
The stock option compensation cost for the first three months of 2019 was $1.6 million (first three months of 2018 – $0.8 million). The total intrinsic value of options exercised in the first three months of 2019 was $2.1 million (first three months of 2018 – $1.9 million).
The total compensation cost related to non-vested stock options not yet recognized at March 31, 2019 was $14.1 million and this cost is expected to be recognized over the weighted-average period of 2.32 years.
The following table summarizes the transactions of the Company’s SEUs for the three months ended March 31, 2019:
At March 31, 2019, there were 41,312 SEUs that are exercisable, of which 37,920 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.
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The SEU compensation cost for the first three months of 2019 was $7.5 million (first three months of 2018 – $1.2 million). The total intrinsic value of SEUs exercised in the first three months of 2019 was $6.2 million (first three months of 2018 - $1.6 million).
The weighted-average remaining vesting period of non-vested SEUs is 2.39 years.
NOTE 15 – RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE LOSS
Reclassifications out of accumulated other comprehensive loss for the first three months of 2019 were:
Details about AOCL Components
Defined benefit pension plan items:
Total reclassifications
These items are included in other income and expense. See Note 7 of the Notes to the Condensed Consolidated Financial Statements for additional information.
Changes in accumulated other comprehensive loss for the first three months of 2019, net of tax, were:
Other comprehensive income before
reclassifications
Amounts reclassified from AOCL
Total other comprehensive income
NOTE 16 – RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2016-13,Financial Instruments – Credit Losses (ASC Topic 326). This replaces the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We will be required to use a forward-looking expected
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credit loss model for accounts receivables, loans, and other financial instruments. Credit losses relating toavailable-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be effective for the Company beginning January 1, 2020. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We are currently evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems.
In February 2018, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2018–02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASC Topic 220), which was adopted by Innospec on January 1, 2019. The update allows entities to elect to reclassify certain stranded income tax effects of the Tax Cuts and Jobs Act on items within accumulated other comprehensive income to retained earnings. Innospec has decided not to make such election for the period.
NOTE 17 – RELATED PARTY TRANSACTIONS
Mr. Robert I. Paller has been a non-executive director of the Company since November 1, 2009. The Company has retained and continues to retain Smith, Gambrell & Russell, LLP (“SGR”), a law firm with which Mr. Paller holds a position. In the first three months of 2019 the Company incurred fees from SGR of $0.2 million (first three months of 2018 – $0.1 million). As at March 31, 2019, the amount due to SGR from the Company was $0.0 million (December 31, 2018 - $0.0 million).
Mr. David F. Landless has been a non-executive director of the Company since January 1, 2016 and is a non-executive director of Ausurus Group Limited which owns European Metal Recycling Limited (“EMR”). The Company has sold scrap metal to EMR in 2019 for a value of $0.3 million. A tendering process is operated to select the best buyer for the sale of scrap metal by the Company. As at March 31, 2019, EMR did not owe any money for scrap metal purchased from the Company.
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This discussion should be read in conjunction with our unaudited interim condensed consolidated financial statements and the notes thereto.
CRITICAL ACCOUNTING ESTIMATES
The policies and estimates that the Company considers the most critical in terms of complexity and subjectivity of assessment are those related to business combinations, environmental liabilities, pensions, income taxes, goodwill and property, plant and equipment and other intangible assets (net of depreciation and amortization). These policies have been discussed in the Company’s 2018 Form 10-K.
RESULTS OF OPERATIONS
The Company reports its financial performance based on the four reportable segments Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives.
The following table provides operating income by reporting segment:
Net sales:
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Three Months Ended March 31, 2019
The following table shows the change in components of operating income by reporting segment for the three months ended March 31, 2019 and the three months ended March 31, 2018:
(in millions, except ratios)
Gross margin (%):
Aggregate
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Net sales: the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:
Change (%)
Volume
Price and product mix
Exchange rates
Volumes in EMEA and ASPAC were higher, driven by increased demand for our products and technology. Volumes in the Americas were slightly lower due to the timing of demand for high volume products following a strong final quarter of 2018. Price and product mix in the Americas and EMEA benefited from increased sales of higher margin products, while ASPAC was adversely impacted by higher sales of lower margin products. AvTel volumes were lower than the prior year due to variations in the demand from customers, together with a favorable price and product mix. EMEA and ASPAC were adversely impacted by exchange rate movements year over year, driven by a weakening of the British pound sterling and the European Union euro against the U.S. dollar.
Gross margin: the year on year increase of 1.9 percentage points benefitted from an improvement in the mix of product sales compared to a weaker prior year comparative.
Operating expenses: the year on year increase of $2.5 million was driven by an increase in the provisions for doubtful debts together with higher personnel related expenses due to increased share-based compensation accruals.
Higher volumes in ASPAC were driven by increased demand for our Personal Care products, together with a favorable price and product mix from increased sales of higher margin products. Price and product mix in the Americas benefitted from increased sales of higher margin products, while EMEA was adversely impacted by lower selling prices for certain products where raw material costs have declined. EMEA and ASPAC were negatively impacted by exchange rate movements year over year, due to a weakening of the British pound sterling and the European Union euro against the U.S. dollar.
Gross margin: the year on year increase of 2.0 percentage points was driven by an improved sales mix, better raw material prices and the continued benefit of several improvement projects.
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Operating expenses: the year on year decrease of $0.2 million was primarily due to lower provisions for doubtful debts.
Net sales:the year on year increase of $21.3 million was due to the continued strength of customer activity in stimulation and completion. Overall volumes increased by 6 percent year on year, together with a favorable price and product mix of 17 percent due to improved pricing.
Gross margin: the year on year decrease of 0.8 percentage points was due to the customer and product mix delivering increased sales of lower margin products.
Operating expenses: the year on year increase of $1.5 million was due to higher selling and technical support expenses required to deliver the increase in customer demand, partly offset by lower agents’ commissions and a reduction in other expenses. The reduction in other expenses is driven by lower general and administration costs due to effective cost control.
Net sales: were nil in the quarter, with indications of a final order from our one remaining refinery customer later in the year.
Gross margin: in the quarter was negative due to lower production volumes and the fixed costs of manufacturing operations.
Operating expenses: were in line with the prior year.
Other Income Statement Captions
Corporate costs:the year on year increase of $2.2 million primarily relates to higher personnel related expenses including higher share-based compensation accruals; partly offset by a reduction for the amortization of our internally developed software and the benefit of a weakening of the British pound sterling against the U.S. dollar for our United Kingdom cost base.
Other net income/(loss): for the first quarter of 2019 and 2018, includes the following:
United Kingdom pension credit
German pension charge
Foreign exchange gains on translation
Foreign currency forward contracts gains/(losses)
Interest expense, net: was $1.5 million in the first quarter of 2018 compared to $1.7 million in the first quarter of 2017 driven by lower average net debt as the business has generated cash inflows.
Income taxes: the effective tax rate was 26.0% and 25.3% for the first three months of 2019 and 2018, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 26.8% in 2019 compared with 24.7% in 2018. The 2.1% increase in the adjusted effective rate was primarily due to the fact that a smaller proportion of the Company’s profits are being generated in low tax jurisdictions. The Company believes that this adjusted
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effective tax rate, a non-GAAP financial measure, provides useful information to investors and may assist them in evaluating the Company’s underlying performance and identifying operating trends. In addition, management uses this non-GAAP financial measure internally to evaluate the performance of the Company’s operations and for planning and forecasting in subsequent periods.
The following table shows a reconciliation of the GAAP effective tax rate to the adjusted effective tax rate:
Income before income taxes
Adjustment for stock compensation
Indemnification asset regarding tax audit
Income taxes
Tax on stock compensation
Adjustment of income tax provision
GAAP effective tax rate
Adjusted effective tax rate
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LIQUIDITY AND FINANCIAL CONDITION
Working Capital
The Company believes that adjusted working capital, a non-GAAP financial measure, (defined by the Company as trade and other accounts receivable, inventories, prepaid expenses, accounts payable and accrued liabilities rather than total current assets less total current liabilities) provides useful information to investors in evaluating the Company’s underlying performance and identifying operating trends. Management uses this non-GAAP financial measure internally to allocate resources and evaluate the performance of the Company’s operations. Items excluded from working capital in the adjusted working capital calculation are listed in the table below and represent factors which do not fluctuate in line with the day to day working capital needs of the business.
Working capital
Less cash and cash equivalents
Less prepaid income taxes
Less other current assets
Add back current portion of accrued income taxes
Add back current portion of long-term debt
Add back current portion of finance leases
Add back current portion of plant closure provisions
Add back current portion of operating lease liabilities
Adjusted working capital
In the first three months of 2019 our working capital increased by $16.3 million, while our adjusted working capital increased by $29.4 million. The difference is primarily due to changes in accrued income taxes and the exclusion of the current portion of operating lease liabilities from our adjusted working capital.
We had a $17.0 million increase in trade and other accounts receivable driven by higher sales quarter on quarter in our Performance Chemicals and Oilfield Services segment. Days’ sales outstanding in our Fuel Specialties segment increased from 52 days to 53 days; increased in our Performance Chemicals segment from 65 days to 66 days; and increased from 56 days to 63 days in our Oilfield Services segment.
We had a $1.1 million increase in inventories with increases in our Fuel Specialties and Octane Additives segments as expected, partly offset by reductions in our Oilfield Services segment due to our continued control of working capital. Days’ sales in inventory in our Fuel Specialties segment increased from 90 days to 103 days; decreased in our Performance Chemicals segment from 59 days to 57 days; and decreased from 82 days to 68 days in our Oilfield Services segment.
Prepaid expenses increased $0.1 million, from $11.6 million to $11.7 million.
We had an $11.2 million decrease in accounts payable and accrued liabilities due to the timing of supplier payments in the quarter. Creditor days in our Fuel Specialties segment decreased from 29 days to 25 days; decreased in our Performance Chemicals segment from 49 days to 47 days; and remained unchanged at 48 days in our Oilfield Services segment.
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Operating Cash Flows
We generated cash from operating activities of $13.2 million in the first quarter of 2019 compared to cash outflows of $2.0 million in the first quarter of 2018. Year over year cash from operating activities has benefitted from our effective control of working capital across our business, in particular our Oilfield Services segment has controlled inventory levels while sales have significantly increased year on year. There has also been a favorable cash flow from the timing of income tax payments.
Cash
At March 31, 2019, and December 31, 2018, we had cash and cash equivalents of $123.5 million and $123.1 million, respectively, of which $102.2 million and $101.4 million, respectively, were held by non-U.S. subsidiaries principally in the United Kingdom.
Debt
At March 31, 2019, we had $126.0 million of debt outstanding under the revolving credit facility, $82.5 million of debt outstanding on our term loan and $2.6 million of obligations under finance leases relating to certain fixed assets within our Fuel Specialties and Oilfield Services segments.
At December 31, 2018, we had $126.0 million of debt outstanding under the revolving credit facility, $82.5 million of debt outstanding on our term loan and $3.3 million of obligations under finance leases relating to certain fixed assets within our Fuel Specialties and Oilfield Services segment.
Item 3 Quantitative and Qualitative Disclosures about Market Risk
The Company uses floating rate debt to finance its global operations. The Company is subject to business risks inherent innon-U.S. activities, including political and economic uncertainty, import and export limitations, and market risk related to changes in interest rates and foreign currency exchange rates. The political and economic risks are mitigated by the stability of the major countries in which the Company’s largest operations are located. Credit limits, ongoing credit evaluation and account monitoring procedures are used to minimize bad debt risk. Collateral is not generally required.
From time to time, the Company uses derivatives, including interest rate swaps, commodity swaps and foreign currency forward exchange contracts, in the normal course of business to manage market risks. The derivatives used in hedging activities are considered risk management tools and are not used for trading purposes. In addition, the Company enters into derivative instruments with a diversified group of major financial institutions in order to manage the exposure to non-performance of such instruments. The Company’s objective in managing the exposure to changes in interest rates is to limit the impact of such changes on earnings and cash flows and to lower overall borrowing costs. The Company’s objective in managing the exposure to changes in foreign currency exchange rates is to reduce volatility on earnings and cash flows associated with such changes.
The Company offers fixed prices for some long-term sales contracts. As manufacturing and raw material costs are subject to variability the Company, from time to time, uses commodity swaps to hedge the cost of some raw materials thus reducing volatility on earnings and cash flows. The derivatives are considered risk management tools and are not used for trading purposes. The Company’s objective is to manage its exposure to fluctuating costs of raw materials.
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The Company’s exposure to market risk has been discussed in the Company’s 2018 Form 10-K and there have been no significant changes since that time.
Item 4 Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Based on an evaluation carried out as of the end of the period covered by this report, under the supervision and with the participation of our management, our Chief Executive Officer and our Chief Financial Officer concluded that the Company’s “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) were effective as of March 31, 2019.
Changes in Internal Control over Financial Reporting
The Company is continuously seeking to improve the efficiency and effectiveness of its operations and of its internal control over financial reporting. This is intended to result in refinements to processes throughout the Company.
We have implemented internal controls to ensure we adequately evaluated our contracts and properly assessed the impact of the new leases standard on our financial statements. As a result there were no significant changes to our internal control over financial reporting due to the adoption of the new standard.
There were no changes to our internal control over financial reporting which were identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II OTHER INFORMATION
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 claims or proceedings could, in the aggregate, have a material adverse effect on results of operations for a particular year or quarter.
Following the filing of our 2018 Form 10-K, there has been an extension of the deadline for the United Kingdom (U.K.) to exit from the European Union (E.U.). On April 11, 2019, the E.U. agreed an extension to the U.K. exit date until October 31, 2019. The U.K. may leave before this date if a withdrawal agreement is agreed and ratified. The risk factors disclosed in our 2018 Form 10-K related to this matter have not changed as a result of the extended exit date.
Information regarding risk factors that could have a material impact on our results of operations or financial condition are described under “Risk Factors” in Item 1A of Part 1 of our 2018 Form 10-K. In management’s view, there have been no material changes in the risk factors facing the Company since that time.
There have been no unregistered sales of equity securities.
On November 6, 2018, the Company announced that its board of directors had approved the repurchase of up to $100 million of Innospec’s common stock over the following three years. During the three months ended March 31, 2019, no shares of our common stock were repurchased by the Company under this share repurchase program.
During the quarter ended March 31, 2019, the company has purchased its common stock in connection with the exercising of stock options by employees. The following table provides information about our repurchases of equity securities in the period.
Issuer Purchases of Equity Securities
Period
February 1, 2019 through February 28, 2019
None.
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Not applicable.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
/s/ PATRICK S. WILLIAMS
/s/ IAN P. CLEMINSON
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