Innospec Inc.: Form 10-Q for the period ended Jun 30, 2024

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 plant closure provisions, pensions, income taxes and goodwill. These policies have been discussed in the Company’s 2023 Form 10-K.

RESULTS OF OPERATIONS

The Company reports its financial performance based on three reportable segments, which are Performance Chemicals, Fuel Specialties and Oilfield Services.

The following table provides sales, gross profit and operating income by reporting segment:

(in millions)

19

Three Months Ended June 30, 2024

The following table shows the changes in sales, gross profit and operating expenses by reporting segment for the three months ended June 30, 2024, and the three months ended June 30, 2023:

(in millions, except ratios)

Performance Chemicals

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

Higher sales volumes for all our regions were driven by increased demand for our personal care and home care products resulting from higher consumer demand. The acquisition of the QGP business has also delivered a volume increase year over year. All our regions recorded an adverse price and product mix due to lower selling prices, driven by lower raw material costs, together with greater demand from consumers for lower priced products.

Gross margin: the year over year increase of 5.4 percentage points was due to margins returning to a more normalized level when compared to the depressed margins in the prior year. Margins have benefited from raw materials pricing reductions in the current year, combining with the favorable impact for our manufacturing efficiency due to the higher production volumes.

Operating expenses: increased $2.2 million year over year due to higher sales commissions, increased amortization for acquired intangible assets relating to the QGP acquisition, increased spending on research and development and higher performance-related remuneration.

Fuel Specialties

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

Sales volumes in all our regions have increased year over year due to increased demand from customers. Price and product mix was adverse in all our regions, with a favorable sales mix being offset by lower pricing resulting from lower raw material costs. AvGas volumes were higher than the prior year due to variations in the demand from customers, together with a favorable price and product mix due to a higher proportion of sales being made to higher margin customers.

Gross margin: the year over year increase of 5.5 percentage points was driven by an improved sales mix from increased sales of higher margin products, together with the easing of raw material and other inflationary pressures and the adverse impact of the Brazil inventory misappropriation and associated costs of exiting the trading relationship in the prior year.

Operating expenses: the year over year decrease of $0.5 million was primarily due to lower provisions for doubtful debts being partly offset by higher research and development expenditure.

Oilfield Services

Net sales: have decreased year over year by $90.1 million, or 45 percent, with the majority of our customer activity concentrated in the Americas region. Sales volumes were adversely impacted by significantly lower production chemical activity in 2024. Management expects to see lower sales volumes continuing in production chemicals through the second half of 2024, with the potential for demand to recover over the near-term, together with the potential growth opportunities in our other oilfield markets.

Gross margin: the year over year decrease of 11.5 percentage points was due to an unfavorable sales mix as customer demand has weakened.

Operating expenses: the year over year decrease of $29.8 million was driven by the lower customer service costs and commissions related to the reduced demand from certain customers, together with lower provisions for doubtful debts and lower performance related remuneration accruals.

Other Income Statement Captions

Corporate costs: the year over year decrease of $2.5 million was primarily due to acquisition related costs in the prior year compared to none in the current year, together with a favorable revaluation for our United Kingdom Emission Trading Scheme credits in the current year compared to an adverse revaluation in the prior year.

Other net income/(expense): for the second quarter of 2024 and 2023, included the following:

(in millions)

Interest income/(expense), net: was income of $2.1 million in the second quarter of 2024 compared to an expense of $0.3 million in the second quarter of 2023, driven by the higher interest income being earned in 2024 for our increasing cash balances.

Income taxes: the effective tax rate was 28.6% and 21.0% in the second quarter of 2024 and 2023, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 28.4% in 2024 compared with 21.0% in 2023. The 7.4 percentage points increase in the adjusted effective rate was primarily due to the fact that a higher proportion of the Company’s profits are being generated in higher tax jurisdictions. The Company believes that this adjusted effective tax rate, a non-GAAP financial measure, provides useful information to investors and may assist them in evaluating the Company’s underlying performance and identifying operating trends. In addition, management uses this non-GAAP financial measure internally to evaluate the performance of the Company’s operations and for planning and forecasting in subsequent periods.

The following table shows a reconciliation of the GAAP effective tax charge to the adjusted effective tax charge:

(in millions)

22

Six Months Ended June 30, 2024

The following table shows the changes in sales, gross profit and operating expenses by reporting segment for the six months ended June 30, 2024, and the six months ended June 30, 2023:

(in millions, except ratios)

Performance Chemicals

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

Higher sales volumes for all our regions were driven by increased demand for our personal care and home care products resulting from higher consumer demand. The acquisition of the QGP business has also delivered a volume increase year over year. All our regions recorded an adverse price and product mix due to lower selling prices, driven by lower raw material costs, together with greater demand from consumers for lower priced products.

Gross margin: the year over year increase of 6.5 percentage points was due to margins returning to a more normalized level when compared to the depressed margins in the prior year. Margins have benefited from raw materials pricing reductions in the current year, combining with the favorable impact for our manufacturing efficiency due to the higher production volumes.

Operating expenses: increased $5.1 million year over year due to higher selling expenses, increased amortization for acquired intangible assets relating to the QGP acquisition, increased spending on research and development and higher performance-related remuneration.

Fuel Specialties

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

Sales volumes in all our regions have increased year over year due to increased demand from customers. Price and product mix was adverse in the Americas and EMEA, with a favorable sales mix being offset by lower pricing resulting from lower raw material costs. ASPAC benefited from a favorable price and product mix due to the increased sales of higher priced products. AvGas volumes were higher than the prior year due to variations in the demand from customers, together with a favorable price and product mix due to a higher proportion of sales being made to higher margin customers.

Gross margin: the year over year increase of 4.7 percentage points was driven by an improved sales mix from increased sales of higher margin products, together with the easing of raw material and other inflationary pressures and the adverse impact of the Brazil inventory misappropriation and associated costs of exiting the trading relationship in the prior year.

Operating expenses: the year over year increase of $1.7 million is due to higher research and development expenditure and higher performance-related remuneration accruals.

Oilfield Services

Net sales: have decreased year over year by $95.5 million, or 26 percent, with the majority of our customer activity concentrated in the Americas region. Sales volumes were adversely impacted by significantly lower production chemical activity in 2024. Management expects to see lower sales volumes continuing in production chemicals through the second half of 2024, with the potential for demand to recover over the near-term, together with the potential growth opportunities in our other oilfield markets.

Gross margin: the year over year decrease of 7.5 percentage points was due to an unfavorable sales mix as customer demand has weakened.

Operating expenses: the year over year decrease of $39.7 million was driven by the lower customer service costs and commissions related to the reduced demand from certain customers, together with lower provisions for doubtful debts and lower performance related remuneration accruals.

Other Income Statement Captions

Corporate costs: are in line with the prior year, including the benefit of no acquisition related costs in the current year being primarily offset by higher information technology investment together with the adverse impact of inflationary increases.

Other net income/(expense): for the first six months of 2024 and 2023, included the following:

(in millions)

Interest income/(expense), net: was income of $4.2 million in the first six months of 2024 compared to nil in the first six months of 2023. Interest income from our cash balances has increased over recent periods due to higher central bank interest rates together with the increases in our cash balances.

Income taxes: the effective tax rate was 26.7% and 23.9% in the first six months of 2024 and 2023, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 26.2% in 2024 compared with 23.6% in 2023. The 2.6 percentage points increase in the adjusted effective rate was primarily due to the fact that a higher proportion of the Company’s profits are being generated in higher tax jurisdictions. The Company believes that this adjusted effective tax rate, a non-GAAP financial measure, provides useful information to investors and may assist them in evaluating the Company’s underlying performance and identifying operating trends. In addition, management uses this non-GAAP financial measure internally to evaluate the performance of the Company’s operations and for planning and forecasting in subsequent periods.

The following table shows a reconciliation of the GAAP effective tax charge to the adjusted effective tax charge:

(in millions)

25

LIQUIDITY AND FINANCIAL CONDITION

Working Capital

In the first six months of 2024 our working capital increased by $29.8 million, while our adjusted working capital increased by $3.6 million. The difference is primarily due to the exclusion of the increases for cash and cash equivalents, together with the changes for prepaid income taxes and the current portion of accrued income taxes.

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.

(in millions)

We had a $59.5 million decrease in trade and other accounts receivable driven by positive cash collections. Days’ sales outstanding decreased in our Performance Chemicals segment from 64 days to 61 days; increased from 55 days to 58 days in our Fuel Specialties segment; and increased from 55 days to 63 days in our Oilfield Services segment.

We had a $13.4 million increase in inventories, including a $10.0 million increase in allowances, driven by higher levels of raw materials. The Company continues to maintain inventory levels necessary to manage the risk of potential supply chain disruption for certain key raw materials, especially in our Fuel Specialties segment. Days’ sales in inventory in our Performance Chemicals segment increased from 62 days to 63 days; increased from 121 days to 141 days in our Fuel Specialties segment; and increased from 48 days to 69 days in our Oilfield Services segment.

Prepaid expenses decreased $9.0 million, from $18.7 million to $9.7 million, primarily due to the normal expensing of prepaid invoices.

We had a $58.7 million decrease in accounts payable and accrued liabilities, which was dependent on the timing of payments for each of our reporting segments. Creditor days (including goods received not invoiced) have increased in our Performance Chemicals segment from 45 days to 48 days; increased from 41 days to 44 days in our Fuel Specialties segment; and increased from 48 days to 51 days in our Oilfield Services segment. The increases for creditor days have been impacted by the timing of sales in the last two months of the quarter.

Operating Cash Flows

We generated cash from operating activities of $85.3 million in the first six months of 2024 compared to $76.8 million in the first six months of 2023. The increase in cash generated from operating activities was related to increased operating income and favorable income tax changes year over year, being partly offset by higher working capital requirements in the current year primarily related to the increased inventory levels needed to secure the supply of certain raw materials.

Cash

At June 30, 2024 and December 31, 2023, we had cash and cash equivalents of $240.2 million and $203.7 million, respectively, of which $77.8 million and $59.8 million, respectively, were held by non-U.S. subsidiaries principally in the United Kingdom.

The increase in cash and cash equivalents of $36.5 million for the first six months of 2024 was driven by our positive trading cash flow, being partly offset by our working capital needs, our continued investments in capital projects and the payment of our semi-annual dividend.

Debt

We continue to have available a $250.0 million multicurrency revolving credit facility (the “Facility”), which contains an accordion feature whereby we may elect to increase the total available borrowings by an aggregate amount of up to $125.0 million. Effective as of May 20, 2024, the termination date of the Facility was extended from May 30, 2027 to May 31, 2028 in accordance with the terms of our multicurrency revolving facility agreement (the “Facility Agreement”). No other terms of the Facility Agreement or the Facility were modified. We paid a customary extension fee in connection with the extension of the Facility as contemplated by the Facility Agreement.

At June 30, 2024, and December 31, 2023, we had no debt outstanding under the revolving credit facility and no obligations were outstanding under finance leases. See Note 8 of the Notes to the Condensed Consolidated Financial Statements for additional information.

The Company uses floating rate debt to finance its global operations. The Company is subject to business risks inherent in non-U.S. activities, including political and economic uncertainty, import and export limitations, and market risk related to changes in interest rates and foreign currency exchange rates. The political and economic risks are mitigated by the stability of the 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.

The Company’s exposure to market risk has been discussed in the 2023 Form 10-K and there have been no significant changes since that time.

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 June 30, 2024, to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and (ii) accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

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.

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, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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 I of our 2023 Form 10-K. In management’s view, there have been no material changes in the risk factors facing the Company as disclosed in those SEC filings.