# INNOSPEC INC. (IOSP) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from INNOSPEC INC.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1054905/000095017024014960/iosp-20231231.htm
Accession: 0000950170-24-014960
Filing date: 2024-02-14
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/IOSP/
All MD&A years: /company/IOSP/mda/
Previous year: /company/IOSP/mda/fy2022/ (FY 2022)
Next year: /company/IOSP/mda/fy2024/ (FY 2024)

Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion should be read in conjunction with our Consolidated Financial Statements and the Notes thereto.

EXECUTIVE OVERVIEW

In 2023 Innospec delivered strong results. We again benefited from our balanced end-market exposure as the negative impact of customer destocking in Performance Chemicals was offset by significant growth in Oilfield Services, and steady results in Fuel Specialties.

In Performance Chemicals, full year sales and operating income declined, but we believe that destocking pressure peaked in the third quarter of 2023. This combined with new contract awards contributed to significant sequential improvement in operating income and margins in the second half of 2023. While the economic environment remains a challenge, we expect further improvement in this business in 2024 as activity levels return. In addition, we acquired QGP which we believe will further strengthen our Performance Chemicals segment and add a manufacturing base in South America to compliment all of our end markets.

In Fuel Specialties, after adjusting for the non-recurring Brazil inventory charges in the first half of 2023, full-year operating income grew and operating margins improved to 18%. Our target for operating margins continues to be 19-21%. Sales growth combined with further margin improvement is a key focus and opportunity for the global Fuel Specialties team in 2024.

Oilfield Services had another excellent full year. Operating income approximately doubled and operating margins improved above our 10% target. While we expect production chemicals activity to remain at moderate levels in 2024, we continue to pursue further sales growth and margin improvement in our other segments.

CRITICAL ACCOUNTING ESTIMATES

Note 2 of the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements.

Plant Closure Provisions

We are subject to environmental laws in the countries in which we conduct business. Ellesmere Port in the U.K. is our principal site giving rise to asset retirement obligations, associated with the production of TEL. There are also asset retirement obligations and environmental remediation liabilities on a much smaller scale in respect of other manufacturing sites. At Ellesmere Port there is a continuing asset retirement program related to certain manufacturing units that have been closed.

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Plant closure provisions at December 31, 2023 amounted to $61.6 million and relate principally to our Ellesmere Port site in the U.K.. We recognize environmental remediation liabilities when they are probable and costs can be reasonably estimated, and asset retirement obligations when there is a legal requirement, including those arising from a Company promise, and the costs can be reasonably estimated. The Company has to anticipate the program of work required and the associated future expected costs, and comply with environmental legislation in the countries in which it operates or has operated in. We develop these assumptions utilizing the latest information available together with recent costs. While we believe our assumptions for plant closure provisions are reasonable, they are subjective estimates and it is possible that variations in any of the assumptions will result in materially different calculations to the liabilities we have reported.

Income Taxes

We are subject to income and other taxes in the U.S., the U.K. and a number of other jurisdictions. Tax laws are dynamic and subject to change as new laws are passed and new interpretations of the law are issued or applied.

The calculation of our tax liabilities involves evaluating uncertainties in the application of accounting principles and complex tax regulations. We recognize liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes will be required. If we ultimately determine that payment of these amounts is unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary.

We also recognize tax benefits to the extent that it is more likely than not that our positions will be sustained, based on technical merits of the position, when challenged by the taxing authorities. To the extent that we prevail in matters for which liabilities have been established or are required to pay amounts in excess of the liabilities recorded in our Consolidated Financial Statements, our effective tax rate in a given period may be materially affected. An unfavorable tax settlement may require cash payments and result in an increase in our effective tax rate in the year of resolution. We report interest and penalties related to uncertain tax positions as income taxes. For additional information regarding uncertain income tax positions, see Note 11 of the Notes to the Consolidated Financial Statements.

Pensions

The Company maintains a defined benefit pension plan covering certain current and former employees in the United Kingdom (“UK Plan”). The UK Plan is closed to future service accrual but has a large number of deferred and current pensioners. The Company also has other smaller pension arrangements in the U.S. and overseas.

In May 2022, the Trustees of the UK Plan entered into an agreement with Legal and General Assurance Society Limited to acquire an insurance policy that operates as an investment asset, with the intent of matching the remaining uninsured part of the UK Plan’s future cash outflow arising from the accrued pension liabilities of members. Such an arrangement is commonly termed as a “buy-in”. The benefit obligation was not transferred to the insurer, and the Company remains responsible for paying pension benefits. The initial value of the asset associated with this contract was equal to the premium paid to secure the contract and is adjusted each reporting period to reflect the estimated fair value of the premium that would be paid for such a contract at that time. The buy-in reduces the UK Plan’s value at risk in relation to key risks associated with improved longevity, inflation and interest rate movements while improving the security to the UK Plan and its members. The Company consequently benefits from the buy-in as it reduces the UK Plan’s potential reliance on the Company for future cash funding requirements.

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Movements in the UK Plan’s Projected Benefit Obligation (“PBO”) are dependent on our assumptions in respect of the discount rate, annual member mortality rates, future return on assets and future inflation. A change in any one of these assumptions could impact the plan asset value, PBO and pension charge recognized in the income statement. Such changes could adversely impact our results of operations and financial position. For example, a 0.25% change in the discount rate assumption would change the PBO at December 31, 2023 by approximately $10.8 million and the net pension credit for 2024 would change by approximately $0.6 million. A 0.25% change in the level of price inflation assumption would change the PBO at December 31, 2023 by approximately $6.9 million and the net pension credit for 2024 by approximately $0.3 million.

Further information is provided in Note 10 of the Notes to the Consolidated Financial Statements.

Goodwill

The Company’s reporting units, the level at which goodwill is assessed for potential impairment, are consistent with the reportable segments. The components in each segment (including products, markets and competitors) have similar economic characteristics and the segments, therefore, reflect the lowest level at which operations and cash flows can be sufficiently distinguished, operationally and for financial reporting purposes, from the rest of the Company.

To test for impairment the Company performs a qualitative step zero assessment to determine whether it is more likely than not (that is, a likelihood of more than 50%) that the fair value of a segment is less than the carrying amount prior to performing the quantitative goodwill impairment test. Factors utilized in the qualitative assessment process include macroeconomic conditions; industry and market considerations; cost factors; overall financial performance; and Company specific events.

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

At December 31, 2023 we had $399.3 million of goodwill relating to our Performance Chemicals, Fuel Specialties and Oilfield Services segments. Our step zero impairment review at December 31, 2023 indicated the fair value of each segment is, more likely than not, higher than the carrying value, meaning no step one impairment review was required to be performed.

30

RESULTS OF OPERATIONS

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

[[GREPCENT_TABLE]]
[["(in millions)","","2023","","","2022","","","2021"],["Net sales:"],["Performance Chemicals","","$","561.6","","","$","639.7","","","$","525.3"],["Fuel Specialties","","","695.9","","","","730.2","","","","618.3"],["Oilfield Services","","","691.3","","","","593.8","","","","339.8"],["","","$","1,948.8","","","$","1,963.7","","","$","1,483.4"],["Gross profit:"],["Performance Chemicals","","$","105.6","","","$","150.0","","","$","125.2"],["Fuel Specialties","","","215.1","","","","221.9","","","","193.2"],["Oilfield Services","","","270.4","","","","214.8","","","","116.5"],["","","$","591.1","","","$","586.7","","","$","434.9"],["Operating income:"],["Performance Chemicals","","$","54.5","","","$","95.3","","","$","70.9"],["Fuel Specialties","","","109.7","","","","121.7","","","","104.6"],["Oilfield Services","","","78.6","","","","41.7","","","","10.4"],["Corporate costs","","","(81.2",")","","","(71.4",")","","","(55.6",")"],["Profit on disposal","","","\u2014","","","","\u2014","","","","1.8"],["Total operating income","","$","161.6","","","$","187.3","","","$","132.1"],["Other income/(expense), net","","$","10.5","","","$","(1.6",")","","$","3.8"],["Interest income/(expense), net","","","2.3","","","","(1.1",")","","","(1.5",")"],["Income before income taxes","","","174.4","","","","184.6","","","","134.4"],["Income taxes","","","(35.3",")","","","(51.6",")","","","(41.3",")"],["Net income","","$","139.1","","","$","133.0","","","$","93.1"]]
[[/GREPCENT_TABLE]]

31

Results of Operations – Fiscal 2023 compared to Fiscal 2022:

[[GREPCENT_TABLE]]
[["(in millions, except ratios)","","2023","","","2022","","","Change"],["Net sales:"],["Performance Chemicals","","$","561.6","","","$","639.7","","","$","(78.1",")","","","-12","%"],["Fuel Specialties","","","695.9","","","","730.2","","","","(34.3",")","","","-5","%"],["Oilfield Services","","","691.3","","","","593.8","","","","97.5","","","","16","%"],["","","$","1,948.8","","","$","1,963.7","","","$","(14.9",")","","","-1","%"],["Gross profit:"],["Performance Chemicals","","$","105.6","","","$","150.0","","","$","(44.4",")","","","-30","%"],["Fuel Specialties","","","215.1","","","","221.9","","","","(6.8",")","","","-3","%"],["Oilfield Services","","","270.4","","","","214.8","","","","55.6","","","","26","%"],["","","$","591.1","","","$","586.7","","","$","4.4","","","","1","%"],["Gross margin (%):"],["Performance Chemicals","","","18.8","","","","23.4","","","","(4.6",")"],["Fuel Specialties","","","30.9","","","","30.4","","","","0.5"],["Oilfield Services","","","39.1","","","","36.2","","","","2.9"],["Aggregate","","","30.3","","","","29.9","","","","0.4"],["Operating expenses:"],["Performance Chemicals","","$","(51.1",")","","$","(54.7",")","","$","3.6","","","","-7","%"],["Fuel Specialties","","","(105.4",")","","","(100.2",")","","","(5.2",")","","","5","%"],["Oilfield Services","","","(191.8",")","","","(173.1",")","","","(18.7",")","","","11","%"],["Corporate costs","","","(81.2",")","","","(71.4",")","","","(9.8",")","","","14","%"],["","","$","(429.5",")","","$","(399.4",")","","$","(30.1",")","","","8","%"]]
[[/GREPCENT_TABLE]]

Financial information with respect to our domestic and foreign operations is contained in Note 3 of the Notes to the Consolidated Financial Statements.

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:

[[GREPCENT_TABLE]]
[["Change (%)","","Americas","","","EMEA","","","ASPAC","","","Total"],["Volume","","","-4","","","","-4","","","","-18","","","","-4"],["Price and product mix","","","-12","","","","-7","","","","+1","","","","-9"],["Exchange rates","","","\u2014","","","","+2","","","","+1","","","","+1"],["","","","-16","","","","-9","","","","-16","","","","-12"]]
[[/GREPCENT_TABLE]]

Lower sales volumes for all of our regions were primarily driven by reduced demand for our personal care products resulting from cautious consumer sentiment, together with the impact of destocking by our customers. The Americas and EMEA were impacted by an adverse price and product mix due to a higher proportion of lower priced products being sold. ASPAC benefited from a favorable price and product mix due to a higher proportion of higher priced products being sold.

Gross margin: the year over year decrease of 4.6 percentage points was due to an adverse sales mix from reduced sales of higher margin products and the adverse impact of reduced manufacturing efficiency resulting from lower production volumes.

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Operating expenses: decreased $3.6 million year over year, due to lower selling expenses including commissions, lower performance-related remuneration accruals and lower acquired intangibles amortization following the end of the expected life of the assets.

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:

[[GREPCENT_TABLE]]
[["Change (%)","","Americas","","","EMEA","","","ASPAC","","","AvGas","","","Total"],["Volume","","","-10","","","","-12","","","","-22","","","","-1","","","","-12"],["Price and product mix","","","+8","","","","+4","","","","+10","","","","-6","","","","+6"],["Exchange rates","","","\u2014","","","","+3","","","","\u2014","","","","\u2014","","","","+1"],["","","","-2","","","","-5","","","","-12","","","","-7","","","","-5"]]
[[/GREPCENT_TABLE]]

Sales volumes in all of our regions have decreased year over year, primarily due to a reduction in the sales of lower margin higher volume products. Price and product mix was favorable in all our regions due to an increased proportion of higher margin products being sold. AvGas volumes were lower than the prior year due to variations in the demand from customers, together with an adverse price and product mix due to a higher proportion of sales to lower margin customers.

Gross margin: the year over year increase of 0.5 percentage points was primarily due to a favorable sales mix from increased sales of higher margin products, being partly offset by the impact of the Brazil inventory misappropriation and the ending of that trading relationship.

Operating expenses: the year over year increase of $5.2 million includes increased research and development expenditure and higher provisions for doubtful debts which are primarily related to the ending of the Brazilian trading relationship, being partly offset by lower performance-related remuneration accruals.

Oilfield Services

Net sales: have increased year over year by $97.5 million, or 16%, with the majority of our customer activity concentrated in the Americas region. We believe that customer demand remains strong despite operating income growth moderating, as expected, through the second half of the 2023.

Gross margin: the year over year increase of 2.9 percentage points was due to a favorable sales mix and the benefit of improved pricing.

Operating expenses: the year over year increase of $18.7 million was driven by higher customer service costs which are necessary to support the increase in demand with certain customers, together with higher provisions for doubtful debts, while being partly offset by lower performance-related remuneration accruals.

Other Income Statement Captions

Corporate costs: the year over year increase of $9.8 million was primarily due to acquisition related costs, additional environmental remediation provisions, increased spending on our information technology infrastructure and some legal costs related to the Brazil inventory misappropriation, being partly offset by lower performance-related remuneration accruals.

33

Other net income/(expense): for 2023 and 2022, includes the following:

[[GREPCENT_TABLE]]
[["(in millions)","","2023","","","2022","","","Change"],["Net pensions credit","","$","6.9","","","$","4.8","","","$","2.1"],["Foreign exchange gains/(losses) on translation","","","7.6","","","","(7.1",")","","","14.7"],["Foreign currency forward contracts gains/(losses)","","","(4.0",")","","","0.7","","","","(4.7",")"],["","","$","10.5","","","$","(1.6",")","","$","12.1"]]
[[/GREPCENT_TABLE]]

Interest income/(expense), net: was income of $2.3 million in 2023 primarily due to the interest earned on the Company's cash balances, compared to a $1.1 million expense in 2022 primarily due to the commitment fee which the Company paid to retain its revolving credit facility for the term of the agreement.

Income taxes: The effective tax rate was 20.2% and 28.0% in 2023 and 2022, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 23.0% in 2023 compared with 27.0% in 2022. 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.

[[GREPCENT_TABLE]]
[["(in millions, except ratios)","","2023","","","2022"],["Income before income taxes","","$","174.4","","","","184.6"],["Adjustment for stock compensation","","","8.0","","","","6.7"],["Indemnification asset regarding tax audit","","","(0.1",")","","","0.1"],["Legacy cost of closed operations","","","6.1","","","","3.5"],["Acquisition costs","","","3.1","","","","\u2014"],["Adjusted income before income taxes","","$","191.5","","","","194.9"],["Income taxes","","$","35.3","","","","51.6"],["Adjustment of income tax provisions","","","1.4","","","","\u2014"],["Tax on stock compensation","","","0.4","","","","0.6"],["Tax loss / (gain) on distribution","","","0.4","","","","\u2014"],["Tax on legacy cost of closed operations","","","1.4","","","","0.7"],["Tax on acquisition costs","","","0.7","","","","\u2014"],["Other discrete items","","","4.5","","","","(0.3",")"],["Adjusted income taxes","","$","44.1","","","","52.6"],["GAAP effective tax rate","","","20.2","%","","","28.0","%"],["Adjusted effective tax rate","","","23.0","%","","","27.0","%"]]
[[/GREPCENT_TABLE]]

The adjusted effective tax rate is higher in 2023 than the GAAP effective tax rate, primarily due to elimination of the impact of other discrete items. This mainly represents the benefit arising from adjustments to the tax charge for previous years arising from return to provision adjustments in relation to the federal and state tax returns filed in the U.S. during 2023.

Our adjusted effective tax rate was lower in 2022 than the GAAP effective tax rate primarily due to the elimination of stock compensation activity.

Foreign income inclusions arise each year from certain types of income earned overseas being taxable under U.S. regulations. Foreign tax credits can fully or partially offset these incremental U.S. taxes from

34

foreign income inclusions. The utilization of foreign tax credits varies year on year as this is dependent on a number of variable factors which are difficult to predict and may prevent offset. The GAAP effective tax rate and the adjusted effective tax rate in both 2023 and 2022 have been negatively impacted by these items.

As a consequence of the Company having operations outside of the U.S., it is exposed to foreign currency fluctuations. These have had a positive impact on the GAAP effective tax rate and adjusted effective tax rate in 2023, and a negative impact in 2022.

As in the prior year, the level of foreign-derived intangible income benefit that the Company is entitled to has also had a positive impact on the GAAP effective tax rate and the adjusted effective tax rate.

For additional information regarding the GAAP effective tax rate in 2023 see Note 11 of the Notes to the Consolidated Financial Statements.

35

Results of Operations – Fiscal 2022 compared to Fiscal 2021:

[[GREPCENT_TABLE]]
[["(in millions, except ratios)","","2022","","","2021","","","Change"],["Net sales:"],["Performance Chemicals","","$","639.7","","","$","525.3","","","$","114.4","","","+22%"],["Fuel Specialties","","","730.2","","","","618.3","","","","111.9","","","+18%"],["Oilfield Services","","","593.8","","","","339.8","","","","254.0","","","+75%"],["","","$","1,963.7","","","$","1,483.4","","","$","480.3","","","+32%"],["Gross profit:"],["Performance Chemicals","","$","150.0","","","$","125.2","","","$","24.8","","","+20%"],["Fuel Specialties","","","221.9","","","","193.2","","","","28.7","","","+15%"],["Oilfield Services","","","214.8","","","","116.5","","","","98.3","","","+84%"],["","","$","586.7","","","$","434.9","","","$","151.8","","","+35%"],["Gross margin (%):"],["Performance Chemicals","","","23.4","","","","23.8","","","","(0.4",")"],["Fuel Specialties","","","30.4","","","","31.2","","","","(0.8",")"],["Oilfield Services","","","36.2","","","","34.3","","","","1.9"],["Aggregate","","","29.9","","","","29.3","","","","0.6"],["Operating expenses:"],["Performance Chemicals","","$","(54.7",")","","$","(54.3",")","","$","(0.4",")","","+1%"],["Fuel Specialties","","","(100.2",")","","","(88.6",")","","","(11.6",")","","+13%"],["Oilfield Services","","","(173.1",")","","","(106.1",")","","","(67.0",")","","+63%"],["Corporate costs","","","(71.4",")","","","(55.6",")","","","(15.8",")","","+28%"],["Profit on disposal","","","\u2014","","","","1.8","","","","(1.8",")","","+100%"],["","","$","(399.4",")","","$","(302.8",")","","$","(96.6",")","","+32%"]]
[[/GREPCENT_TABLE]]

Financial information with respect to our domestic and foreign operations is contained in Note 3 of the Notes to the Consolidated Financial Statements.

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:

[[GREPCENT_TABLE]]
[["Change (%)","","Americas","","","EMEA","","ASPAC","","Total"],["Volume","","+20","","","-9","","+7","","+2"],["Price and product mix","","+20","","","+33","","+18","","+28"],["Exchange rates","","","\u2014","","","-14","","-7","","-8"],["","","+40","","","+10","","+18","","+22"]]
[[/GREPCENT_TABLE]]

Higher sales volumes for the Americas and ASPAC were primarily driven by increased demand for our personal care products. Lower sales volumes for EMEA were due to reductions in demand for our home care products when compared to strong sales volumes in the prior year. All our regions benefited from a favorable price and product mix due to increased sales of higher priced products together with the impact of increased raw materials pricing being passed on through higher selling prices. EMEA and ASPAC were adversely impacted by exchange rate movements year over year, due to a strengthening of the U.S. dollar against the British pound sterling and the European Union euro.

36

Gross margin: the year over year decrease of 0.4 percentage points was primarily due to adverse manufacturing variances and higher raw materials costs in the fourth quarter of 2022, being partly offset by a favorable sales mix from increased sales of higher margin products.

Operating expenses: the year over year increase of $0.4 million was due to higher selling expenses to support our increased sales and higher personnel-related expenses, including higher share-based compensation accruals and higher performance-related remuneration accruals; being partly offset by lower provisions for doubtful debts.

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:

[[GREPCENT_TABLE]]
[["Change (%)","","Americas","","","EMEA","","ASPAC","","AvGas","","","Total"],["Volume","","+10","","","-11","","+11","","+4","","","","\u2014"],["Price and product mix","","+28","","","+32","","+14","","-7","","","+26"],["Exchange rates","","","\u2014","","","-17","","-4","","","\u2014","","","-8"],["","","+38","","","+4","","+21","","-3","","","+18"]]
[[/GREPCENT_TABLE]]

The Americas and ASPAC sales volumes have increased year over year as the global demand for refined fuel products has increased. EMEA sales volumes were lower year over year primarily due to a reduction for the sales of higher volume lower margin products. Price and product mix was favorable in all our regions due to a favorable sales mix with an increased proportion of sales of higher margin products, together with the impact of increased raw materials pricing being passed on through higher selling prices. AvGas volumes were higher than the prior year due to variations in the demand from customers, being offset by an adverse price and product mix with a higher proportion of sales being made to lower margin customers. EMEA and ASPAC were adversely impacted by exchange rate movements year over year, due to a strengthening of the U.S. dollar against the British pound sterling and the European Union euro.

Gross margin: the year over year decrease of 0.8 percentage points was due to the impact of the time lag for passing higher raw material costs through to selling prices.

Operating expenses: the year over year increase of $11.6 million was due to higher personnel-related expenses, including higher share-based compensation accruals, higher travel expenses, increased sales promotions and increased provisions for doubtful debts.

Oilfield Services

Net sales: have increased year over year by $254.0 million, or 75%, with the majority of our customer activity being concentrated in the Americas region. Customer demand has increased through each quarter in 2022.

Gross margin: the year over year increase of 1.9 percentage points was due to a favorable sales mix, while management are continuing to maintain prices in a competitive market.

Operating expenses: the year over year increase of $67.0 million was driven by higher customer service costs which are necessary to support the increase in demand, together with higher personnel-related expenses, including higher share-based compensation accruals and higher performance-related remuneration accruals, and increased provisions for doubtful debts.

37

Other Income Statement Captions

Corporate costs: the year over year increase of $15.8 million was driven by higher personnel-related expenses, including higher share-based compensation accruals and higher performance-related remuneration accruals, together with increased maintenance expenditure for our information technology infrastructure.

Profit on disposal: in the prior year there was a profit on disposal of $1.8 million, which principally related to the sale of land within our oilfield services business in the U.S..

Other net income/(expense): for 2022 and 2021, includes the following:

[[GREPCENT_TABLE]]
[["(in millions)","","2022","","","2021","","","Change"],["Net pensions credit","","$","4.8","","","$","5.4","","","$","(0.6",")"],["Foreign exchange gains/(losses) on translation","","","(7.1",")","","","(2.6",")","","","(4.5",")"],["Foreign currency forward contracts gains/(losses)","","","0.7","","","","1.0","","","","(0.3",")"],["","","$","(1.6",")","","$","3.8","","","$","(5.4",")"]]
[[/GREPCENT_TABLE]]

Interest expense, net: was $1.1 million in 2022 compared to $1.5 million in 2021. Interest expense includes a commitment fee to retain the Company’s revolving credit facility for the term of the agreement.

Income taxes: The effective tax rate was 28.0% and 30.7% in 2022 and 2021, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 27.0% in 2022 compared with 22.7% in 2021. 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.

[[GREPCENT_TABLE]]
[["(in millions, except ratios)","","2022","","","2021"],["Income before income taxes","","$","184.6","","","","134.4"],["Adjustment for stock compensation","","","6.7","","","","4.4"],["Indemnification asset regarding tax audit","","","0.1","","","","0.1"],["Legacy cost of closed operations","","","3.5","","","","3.4"],["Acquisition costs","","","\u2014","","","","0.8"],["Adjusted income before income taxes","","$","194.9","","","","143.1"],["Income taxes","","$","51.6","","","","41.3"],["Adjustment of income tax provisions","","","\u2014","","","","(0.5",")"],["Tax on stock compensation","","","0.6","","","","1.3"],["Tax loss / (gain) on distribution","","","\u2014","","","","(0.2",")"],["Change in UK statutory tax rate","","","\u2014","","","","(7.3",")"],["Tax on legacy cost of closed operations","","","0.7","","","","(1.5",")"],["Tax on acquisition costs","","","\u2014","","","","0.2"],["Other discrete items","","","(0.3",")","","","(0.8",")"],["Adjusted income taxes","","$","52.6","","","","32.5"],["GAAP effective tax rate","","","28.0","%","","","30.7","%"],["Adjusted effective tax rate","","","27.0","%","","","22.7","%"]]
[[/GREPCENT_TABLE]]

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The GAAP effective tax rate and adjusted effective tax rate in 2022 were negatively impacted by foreign income inclusions, net of foreign tax credits, which arise each year from certain types of income earned overseas being taxable under U.S. tax regulations.

As a consequence of the Company having operations outside of the U.S., it is exposed to foreign currency fluctuations. These also had a negative impact on the GAAP effective tax rate and adjusted effective tax rate in 2022.

The adjusted effective tax rate is lower than the GAAP effective tax rate, primarily due to elimination of stock compensation activity to better reflect the Company’s underlying business performance.

The most significant factor impacting our adjusted effective tax rate in 2021 was elimination of the impact of the increase in the U.K. statutory income tax rate.

LIQUIDITY AND FINANCIAL CONDITION

Working Capital

In 2023 our working capital increased by $47.4 million, while our adjusted working capital decreased by $24.5 million. The difference between these measures is primarily due to the exclusion of the increase in our cash and cash equivalents, together with the movements for income taxes.

The Company believes that adjusted working capital, a non-GAAP financial measure, provides useful information to investors in evaluating the Company’s underlying performance and identifying operating trends. Management uses this non-GAAP financial measure internally to allocate resources and evaluate the performance of the Company’s operations. Items excluded from the adjusted working capital calculation are listed in the table below and represent factors which do not fluctuate in line with the day to day working capital needs of the business.

[[GREPCENT_TABLE]]
[["(in millions)","","2023","","","2022"],["Total current assets","","$","885.7","","","$","872.6"],["Total current liabilities","","","(371.5",")","","","(405.8",")"],["Working capital","","","514.2","","","","466.8"],["Less cash and cash equivalents","","","(203.7",")","","","(147.1",")"],["Less prepaid income taxes","","","(2.8",")","","","(3.3",")"],["Less other current assets","","","(0.6",")","","","(0.4",")"],["Add back current portion of accrued income taxes","","","2.6","","","","18.4"],["Add back current portion of plant closure provisions","","","4.6","","","","5.3"],["Add back current portion of operating lease liabilities","","","13.6","","","","13.9"],["Add back current portion of unrecognized tax benefits","","","1.2","","","","\u2014"],["Adjusted working capital","","$","329.1","","","$","353.6"]]
[[/GREPCENT_TABLE]]

The movements in our adjusted working capital are explained as follows:

We had a $25.2 million increase in trade and other accounts receivable primarily driven by increased trading activity and timing of sales across our reporting segments. Days’ sales outstanding in our Performance Chemicals segment increased from 60 days to 62 days; increased in our Fuel Specialties segment from 54 days to 55 days; and increased from 54 days to 72 days in our Oilfield Services segment.

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We had a $73.0 million decrease in inventories, net of a $1.0 million increase in allowances, as we manage inventory levels necessary to support future demand, whilst mitigating the risk of potential supply chain disruption for certain key raw materials. Days’ sales in inventory in our Performance Chemicals segment decreased from 78 days to 61 days; decreased in our Fuel Specialties segment from 138 days to 121 days; and decreased from 58 days to 53 days in our Oilfield Services segment.

Prepaid expenses increased $4.6 million, from $14.1 million to $18.7 million principally due to the timing of prepaid invoices.

We had a $18.7 million decrease in accounts payable and accrued liabilities primarily due to the timing of supplier payments. Creditor days (including goods received not invoiced) remained unchanged in our Performance Chemicals segment at 42 days; decreased in our Fuel Specialties segment from 45 days to 41 days; and decreased from 54 days to 53 days in our Oilfield Services segment.

Operating Cash Flows

We generated cash from operating activities of $207.3 million in 2023 compared to $81.7 million in 2022. The increase is primarily related to the decrease in our working capital together with the improvements in our earnings before depreciation and amortization, being partly offset by income tax payments.

Cash

As at December 31, 2023 and 2022, we had cash and cash equivalents of $203.7 million and $147.1 million, respectively, of which $59.8 million and $76.4 million, respectively, were held by non-U.S. subsidiaries principally in the U.K..

The $56.6 million increase in cash and cash equivalents in 2023 was driven by the cash inflows from operating activities and lower working capital needs, partly offset by the acquisition payment for a business in Brazil, continued investments in capital projects, payments for income taxes and the payment of our semi-annual dividends.

Debt

As at December 31, 2023 and 2022, the Company had repaid all of its borrowings under the revolving credit facility and as a result, the related deferred finance costs of $1.2 million (December 31, 2022 – $0.6 million) are now included within other current and non-current assets at the balance sheet date.

On May 31, 2023, Innospec Inc. and certain subsidiaries of the Company entered into a Multicurrency Revolving Facility Agreement with various lenders, providing for a $250,000,000 four-year multicurrency revolving loan facility. The Agreement also contains an accordion feature whereby the Company may elect to increase the total available borrowings by an aggregate amount of up to $125,000,000. The termination date of the facility is May 30, 2027, but the Company has an option to request an extension of the facility for a further year. The agreement replaced the Company’s credit facility agreement dated September 26, 2019. See Note 12 to the Notes to the Consolidated Financial Statements for additional details.

The revolving credit facility contains terms which, if breached, would result in it becoming repayable on demand. It requires, among other matters, compliance with the following financial covenant ratios measured on a quarterly basis: (1) our ratio of net debt to EBITDA must not be greater than 3.5:1.0 and (2) our ratio of EBITDA to net interest must not be less than 4.0:1.0. Management has determined that

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the Company has not breached these covenants and does not expect to breach these covenants for the next 12 months.

The revolving credit facility contains restrictions which may limit our activities as well as operational and financial flexibility. We may not be able to borrow if an event of default is outstanding, which includes a material adverse change to our assets, operations or financial condition. The credit facility contains a number of restrictions that limit our ability, among other things, and subject to certain limited exceptions, to incur additional indebtedness, pledge our assets as security, guarantee obligations of third parties, make investments, effect a merger or consolidation, dispose of assets, or materially change our line of business.

At December 31, 2023, we had no debt outstanding under the revolving credit facility and no obligations under finance leases.

Contractual Commitments

The following represents contractual commitments at December 31, 2023 and the effect of those obligations on future cash flows:

[[GREPCENT_TABLE]]
[["(in millions)","","Total","","","2024","","","2025-26","","","2027-28","","","Thereafter"],["Operating activities"],["Operating lease liabilities","","","45.2","","","","13.6","","","","15.3","","","","4.8","","","","11.5"],["Operating lease future commitments","","","5.8","","","","0.7","","","","1.6","","","","1.6","","","","1.9"],["Interest payments on debt","","","3.8","","","","1.1","","","","2.2","","","","0.5"],["Investing activities"],["Capital commitments","","","33.7","","","","29.5","","","","4.2"],["Internally developed software","","","8.9","","","","8.9"],["Total","","$","97.4","","","$","53.8","","","$","23.3","","","$","6.9","","","$","13.4"]]
[[/GREPCENT_TABLE]]

Operating activities

Operating lease commitments relate primarily to right-of-use assets at third-party manufacturing facilities, office space, motor vehicles and various items of computer and office equipment which are expected to be renewed and replaced in the normal course of business.

The estimated payments on debt are the commitment fees for our $250.0 million revolving credit facility. Any interest income has been excluded.

Due to the uncertainty regarding the nature of tax audits, particularly those which are not currently underway, it is not meaningful to predict the outcome of obligations related to unrecognized tax benefits. Further disclosure is provided in Note 11 of the Notes to the Consolidated Financial Statements.

Investing activities

Capital commitments relate to certain capital projects that the Company has committed to undertake.

Internally developed software relates to the planned completion costs for the implementation of our new Enterprise Resource Planning system for EMEA and ASPAC, including the acquisition costs for the software as well as the external and internal costs of the development.

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Outlook

Our business teams delivered a strong overall 2023 result. Despite our expectation for continued economic headwinds in the coming quarters, we enter 2024 with optimism. Our growing pipeline of technology-based organic opportunities will continue to advance in parallel with the integration of our recent acquisition of QGP.

Over the medium to long-term, we do not expect any change in our customers’ drive towards cleaner formulations, lower carbon footprint and operational efficiency. We plan to continue our investment in R&D to improve our products and technology. We believe our innovative chemistries and highly responsive technical service directly support our customers’ priorities.

Cash generation was excellent in 2023, and our debt-free, net cash position remained at over $200 million after funding the QGP acquisition. Entering 2024 we expect to have significant flexibility and balance sheet strength for further M&A, dividend growth, and organic investment.

Environmental Matters and Plant Closures

Under certain environmental laws the Company is responsible for the environmental remediation of hazardous substances or wastes at currently or formerly owned or operated properties.

As most of our manufacturing operations have been conducted outside the U.S., we expect that liability pertaining to the investigation and environmental remediation of contaminated properties is likely to be determined under non-U.S. law.

We evaluate costs for environmental remediation, decontamination and demolition projects on a regular basis. Full provision is made for those costs amounting to $61.6 million at December 31, 2023. See Note 13 of the Notes to the Consolidated Financial Statements for further details. Expenditure utilizing these provisions was $4.9 million, $4.2 million and $5.3 million in the years 2023, 2022 and 2021, respectively.

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